“A reason for optimism is that global financial institutions’ balance sheets have strengthened substantially since the 2008 crisis. Reasons for pessimism are that interest rates remain low, debt levels exceptional and many asset prices high. Vulnerabilities include several emerging markets, China, Brexit-hit Britain, Italian sovereign debt and US stocks.”
Martin Wolf, Financial Times, 29 December 2019
Between 2006 and around 2011, Issues which keep me awake at night was my signature publication for, first, Lehman Brothers, and, later, Nomura International. Since then, as a title it has been on the back-burner even though I have never abandoned it entirely. However, given the myriad political uncertainties confronting us through 2019 (and beyond) and the significant impact which some at least stand to have on the global economy, this seems a very appropriate time to bring it back to the fore.
Talk of ‘uncertainties’ prompts me to underline that what follows is not really a forecast. Rather, it is commentary around my five major political ‘known unknowns’ (in order of concern) in what promises to be a very bumpy year (as stock markets in particular are already suggesting), even discounting for the potential ‘black swan’ event.
[Note: For readers who have not had enough of firm forecasts in the past few weeks and who have access to the Financial Times (FT), I recommend the 29 December article ‘Forecasting the World in 2019’, from which the above quote is taken as well as several below.]
My aim is be as brief as I reasonably can in this article, hyperlinking to more detail where necessary/helpful and aiming to follow up with further articles on individual issues when appropriate.
All this being said. and as I frequently underline to my clients, no matter what is going on in politics, always keep in mind that the US Federal Reserve (and other major central banks) will continue to be a — possibly the — major player, as Chairman Jay Powell demonstrated yet again on 4 January.
1. China: Domestic concerns to dominate
“No one…is likely to misinterpret the party’s signals in a year that will be florescent with symbolism. As the party often reminds officials around the country, unrest should be nipped in the bud.”
The Economist, 3 January 2019 (in an article focusing on the international flower festival due to open in Yanqing on 29 April and run for five months)
There is no question other than that China’s leaders are worried.
To an extent, their concerns are certainly justified. Top of the list is the slowdown in the economy which would probably be happening even in the absence of heightened trade tensions with the United States. It must now be clear too that the China ‘hawks’ — Robert Lighthizer and Peter Navarro on trade, Michael Pompeo and John Bolton on national security — appear firmly to have the upper hand advising Mr Trump on China/US relations, of which trade is only one dimension.
Senior representatives of China and the US are due to meet in Beijing on 7/8 January for the first time since a temporary ceasefire was called on 1 December. Beijing is clearly keen to reach an agreement which would stave off the threatened escalation on US tariffs on 1 March, to which end the Chinese will hope to exploit Mr Trump’s love of ‘the deal’.
In this, I believe the senior echelon of the Communist Party of China (CPC) is driven significantly by two related considerations of questionable justification, as follows.
- Economic growth: Remember when China’s leaders appeared to believe that their grip on power would come under serious threat if (claimed) GDP growth per annum fell into single digits; and, later, below 8%? Well, here we are at six and, so far, no real threat of this sort seems to have materialised. Furthermore, I doubt one would were GDP growth to fall somewhat further short of outright recession as a result (primarily) of a Sino/US trade war. But it is far from clear that the senior echelon of the CPC shares my view.
- Paranoia: The world over, revolutionaries who succeed in seizing power are paranoid about popular uprisings — and the CPC is certainly no exception. In 2019 it has to manage several important anniversaries, most notably: the 100th anniversary of the launch of the 4 May Movement (which led to the forming of the CPC) on 4 May; the 30th anniversary of the suppression of the Tiananmen Square protests on 4 June; and the 70th anniversary of the founding of the People’s Republic on 1 October. Concern that any one of these could trigger protests on the street is seriously overdone among the leadership, in my opinion; but that won’t stop it weighing on policy decisions.
More positively in my view, I suspect that US pressure may be providing some additional leverage to those in the CPC who do not entirely share President Xi Jinping’s commitment to state dominance of the economy and wish to see China revert to the trajectory launched by Deng Xiaoping.
Thus, although it is not a conviction call, I think that the Chinese should just about manage to make sufficient concessions to stave of tariff hikes on 1 March, thereby allowing Mr Trump in indulge in claims of ‘victory’. BUT — and this is a conviction call — even if they do, this is far from the end of the story as this US openly pursues a policy of trying to contain China’s rise through trade measures, ie what a have referred to (relatively optimistically given its history) as the 21st century equivalent of Thucydides’s trap; and of forcing profound economic change in China to an extent which even the liberals in the CPC would find hard to swallow.
There is, therefore, a high probability, in my view, that, even if we do miss this particular bullet on 1 March, we shall see a re-escalation later in the 2019 — and especially when Mr Trump needs more distractions from rising domestic pressures (as I explore further in my fifth issue below). Alan Beattie put it thus in the FT recently:
“The US in effect says that to avoid more tariffs on goods from China, the agreement struck between Mr Trump and Mr Xi in December means China must start to dismantle its entire state-interventionist development model in the next three months. This will not happen. The US will resume increasing tariffs on imports from China before midyear.”
Mr Trump is not the only leader likely to look to foreign policy in the face of domestic woes. Xi Jinping too will look for distractions if trade tensions result in slower economic growth.
Contrary to what some commentators appear to believe, I do not personally think that the South China Sea is a likely theatre for such distractions. After all, China seems largely to have achieved its objectives there and there is little if anything to be gained by actions which would rattle the other littoral states. Which is not categorically to rule out a serious clash between the PLA and US forces in the area; but I firmly believe that this would be the result of an accident or error of judgement rather than by design. In other words, and reverting to the FT’s 2019 forecast, I tend to agree with Jamil Anderlini writing as follows:
“Beijing will continue quietly to build up and militarise the artificial islands in the South China Sea but will not make any bolder moves, at least in 2019.”
The same is almost certainly true for Taiwan. However, I suspect, as I have noted in a number of recent articles, that the risk of 2019 crisis may be greater here, a view which has been reinforced by Xi Jinping’s most recent reiteration of his determination to reunite mainland China with its breakaway neighbour.
[9 January addendum: For more on this issue I recommend this 7 January article by Peter Apps, published by Reuters.
On a (mildly) positive note, on 6 January the ruling DPP in Taiwan elected Cho Jung-tai as its new leader (to succeed President Tsai Ing-wen who stepped down over November's disappointing local election results). He took an impressive 73% of the vote. By DPP standards he is a moderate — unlike his opponent You Ying-lung who had the backing of the pro-independence hardliners.]
2. Oil: Conflicting forces
“Oil prices have plunged in the past three months thanks to runaway production growth in the US, and gathering clouds over the economic outlook. Both factors will persist in 2019.”
Ed Crooks, Financial Times, 29 December 2018
At the outset, I would recall that by the end of 2018 the oil price had fallen by around 40% from its October 2018 four-year high of over USD86 per barrel (pb) for Brent crude. And that this high marked a price increase of around one-third since the start of 2018. On the other hand, with many forecasters joining Mr Crooks in forecasting a price below USD60pb come 31 December 2019 and despite a 3% fall as the new year began, Brent is currently on track for its best week for two years, rising 11.6% since 1 January.
There is no single explanation for this latest rally. But included in the mix are:
- A reported reduction in Opec’s output last month even before the cuts agreed at its 6 December meeting are implemented;
- A drop in US output at the end of December as rigs are taken offline in response to lower prices;
- The failure of an expected drawdown of the US domestic stockpile to materialise; and
- An uptick in sentiment over global economic prospects following the announcement of this week’s Sino-US trade talks (see Issue 1 above).
I would not claim that my reading of the relevant commentaries this past week has been comprehensive; indeed, far from it. However, in all that I have read I have barely seen a mention (including from Mr Crooks) of what could yet prove to be the proverbial elephant in the room as far as the oil price is concerned, ie Iran.
If there was a surprise around Washington’s 5 November reintroduction of oil sanctions against Iran, it was that eight countries were granted — admittedly temporary — partial waivers of up to 180 days (on which Iran recently claimed there is total compliance). But I suspect that this may in significant part have been in an effort to prevent the politically sensitive gasoline price from spiking before the midterms. Especially with that election out of the way, I find to hard to believe that Mr Trump will not look shortly to turn the screw still harder on Iran, not least because (as I wrote on 23 October) this is very popular with his white evangelical base.
I should at this point be very clear that, although I have frequently remarked that a ‘wag the dog’-type military action by the US is significantly more likely against Iran than North Korea, this is far from being my base case. But I certainly cannot rule it out — or, for that matter, a crisis-inducing miscalculation of some sort — especially as long as the likes of John Bolton have the President’s ear. In any case, there is much which falls short of a US strike which could not only further inhibit Iran’s ability to sell its oil internationally but also raise tensions generally in one of the world’s most vulnerable channels for hydrocarbons, ie the Gulf.
As David Sheppard wrote in the FT back in April (specifically about the related risk to oil posed by Saudi Arabia’s intervention in Yemen):
“Oil traders should be paying attention.”
3. Emerging Markets: Cold Turkey for corporates
“The overall shape [emerging markets] are in has a lot more cracks now than it did five years ago and certainly at the time of the global financial crisis. It’s both external and internal conditions.”
Carmen Reinhart, 15 May 2018
There is one EM in particular which causes me concern. But let me start by dealing very briefly with a handful of others, not least because of my long-held view that a crisis in one EM would be unlikely to prove systemic whereas simultaneous, even if basically unrelated, shocks in two or three important ones could. As follows (in alphabetical order):
- Argentina: Irrespective of its ultimate outcome (and it is far from certain that President Mauricio Macri will secure a second term), the 27 October general election poses a threat to economic stability (and the implementation of the IMF programme) via what promises to be a very heated campaign;
- Brazil: I accept that there is a case for some optimism over economic prospects under President Jair Bolsonaro; however, divisions of view within the newly appointed cabinet and the fact that the President’s party holds less than 10% of the seats in Brazil’s sclerotic congress has me leaning firmly towards inevitable disappointment for investors, as well as many who voted for him;
- India: My personal view remains that Narendra Modi’s BJP will win the general election due in April/May, albeit with a reduced number of seats (and possibly needing coalition partners for a majority); but we could be in for a shock albeit one which would not be as big as the BJP’s unexpected defeat in 2004;
- Indonesia: Similarly Indonesia’s 17 April general election, a re-run of the 2014 contest between Joko Widodo and Prabowo Subianto, which the former is by no means sure to win even though Indonesia’s (notoriously unreliable) opinion polls place him as favourite;
- South Africa (9 January addendum): The current South Africa parliamentary session expires on 6 May and a general election must be held no later than 4 August (and, most likely, in May); there now seems to be little risk of the ruling ANC's share of the vote falling below 50% but expect more populist (and potentially market-upsetting) measures between now and polling day in an effort to secure a two-thirds majority in the legislature.
So to my biggest concern, ie Turkey, which will hold important local elections no later than 31 March. The economy appears to be in recession and could remain so for most of this year. The currency may have recovered somewhat from its September lows (ie during a major row with the US, now seemingly put largely to one side), but it is still down around 30% year-on-year. This combination is putting a major strain on literally thousands of Turkish corporates addicted to credit which is no longer available to them and which are either technically bankrupt already or heading that way.
Faced with the prospect of embarrassing — even damaging — electoral defeats for his party, it is not at all clear how the mercurial President Recep Tayyip Erdoğan will respond in the coming weeks. But we may be sure that, after a choppy 2018, investors will be watching him closely.
4. Europe: Populism to prevail?
“Elections for the European Parliament may have struggled to gain attention in the past, but this one, to be held on May 23-26, has the potential to be the most consequential in decades. Far-right or nationalist forces are on the march in practically every EU country, challenging establishment parties that continue to espouse, sometimes halfheartedly, mainstream pro-EU views.”
Ben Hall, Financial Times, 28 December 2018
- Italian deputy prime minister Matteo Salvini’s Lega could see the number of seats it holds increase from five to 29;
- In Germany, Alternative für Deutschland should double its tally from seven to 14; and,
- France’s Marine Le Pen’s rebranded Rassemblement national (RN) looks likely to push President Emmanuel Macron’s La République en Marche into second place (as Mr Macron’s stated aim of creating a pan-EU movement based on his party looks to have faltered before it even really started).
However, this all needs to be kept in proportion — for example, RN (in common with Hungary’s ruling Fidesz which is also expected to do well) is already strong in the European Parliament. So, the overall gains of the far right may not be as great as some fear (and its members themselves seem to expect), perhaps taking it from around 20% to no more than 25% of the 705 seats available following the withdrawal from the EU of the UK (which means the loss of UKIP MEPs, of course).
This could even leave the main centre-left and centre-right blocks in the parliament (ie the PES and EPP respectively, noting that Fidesz is currently a member of the latter) with a joint majority, although the meltdown in the centre-left vote across Europe does put this long-standing balance of power in jeopardy.
In any case, although there appears to be no risk whatsoever of populists seizing outright control (even if the various nationalists parties can agree among themselves which, immigration aside, is something they have been singularly unsuccessful at doing historically), building coalitions to push through legislation does look like it will be more difficult still in the incoming parliament. But this does not diminish my two main concerns, ie:
- A strong performance by the nationalists will further boost Mr Salvini, increasing the likelihood of a renewed — and more serious — confrontation between Rome and Brussels in the following months, eg around Italy’s 2020 budget; and,
- Nationalist gains will strengthen the credibility of the relevant parties generally with the result that they will pose an even greater threat come the next major national election cycle in 2021/22 (a theme on which I focused for one of my clients back in early 2017 — copies available by email on request).
Combined, these factors are likely to make it still more difficult for Mr Macron to persuade north European eurozone members to back his ambitious reform agenda unless, that is, he can somehow rediscover his mojo domestically in the wake of the ongoing gilets jaunes protests.
Meanwhile, of course, there is Brexit where the ruling Conservative Party’s populist nationalist wing now appears to have a realistic chance of achieving its ‘hard’ exit goal come 29 March — probably a better one than Prime Minister Theresa May has of getting her deal through parliament in a vote which seems likely to be held on 15 January (with the debate starting this week) and which must take place no later than the 21st. Recent opinion polls suggest that, although Mrs May is arguably correct in her claim that her deal is the only realistic one which delivers on the 2016 referendum outcome while offering the UK economy some protection against the consequences of leaving the EU, fewer than one quarter of voters support it.
The third option, seemingly supported by around half the electorate, is a second referendum, as forecast by the FT’s Philip Stephens who believes, consistent with opinion polling, that this would result in a vote to remain in the EU. But even he feels obliged to add that:
“This prediction is offered as much in hope as expectation!”.
5. United States: Donald doubles down
“Which gets me on to Trumpenomics. Last December’s tax cut injected roughly $1.5tn into the economy. But where is the growth going? Some of it is showing up in continued jobs creation, which is chugging along at roughly the same monthly rate as for most of the past five years. The majority of it is heading into higher asset prices. There is little sign of the new investment, overseas capital repatriation or middle-class income growth that the likes of [Messrs] Kudlow, Hassett and Trump are trumpeting. Next year the stimulative effects of the tax cut will wear off fairly quickly.”
Edward Luce — ‘Swamp Notes’, Financial Times, 21 September 2018
It may come as a surprise to some that I rank the US only fifth among my ‘top five’ issues. But this is based not on the damage which I believe Mr Trump is likely to inflict on the wider world, the prime examples of which are highlighted in my top two issues, but on what I expect of the United States domestically.
Politically, I go largely with the consensus in believing that Mr Trump will come under more and more pressure at home, in particular from House Democrats, irrespective of the outcome of Robert Mueller’s investigations (in connection with which the grand jury has just been granted a six-month extension). Despite the previously stated (but now, possibly, watered down) opposition of House Speaker Nancy Pelosi and the fact that such a move could backfire on the Democratic Party come 2020, I put a 50% probability on the House voting for impeachment this year even though such a motion appears doomed to fail in the Senate.
From Mr Trump’s perspective, with the Democratic Party already in election mode he will also have firm targets at which to fire, ie his potential opponents in 2020, which will play to one of his key strengths. More generally, it is now absolutely clear that his main focus will be to continue to pander to his base with the aim of keeping his approval rating above 40%, where it has been steady for some months now, bearing in mind that even 45% of the popular vote in 2020 could be sufficient to secure him a second term.
In short, we are in for an exceptionally rough and dirty two years in US domestic politics even relative to the past two!
As for the economy, regular readers may recall that I used the quote from Mr Luce at the start of this section in an article published a few weeks ago, going on to note that:
“Just two months downstream, it appears that Mr Luce may have been a trifle optimistic as to how quickly some of the sheen would start to come off the economy — at least from an investors’ perspective if the recent performance of the stock market is anything to go by.”
Since then stock valuations have, of course, slid fairly significantly but by no means decisively. I was therefore particularly interested to read in the 5 January edition of The Economist about two models, both created by economists at JP Morgan, one of which is putting a whopping 91% on the probability of recession in America this year and the other of which puts the probability of such at just 26%!
The former seems to me to be far too high. But such is the degree of uncertainty that I have no problem with the idea that the probability of recession in the US in 2019 could be as low as 26% or even double that — depending in significant part on what exactly Mr Trump does (or even just says) in the coming weeks and months to try to shore up his base.
This being said, while having no clear idea personally as to how close we are to the end of the economic cycle, I continue to sympathise with the concluding paragraph of Mr Luce’s article, as follows:
“This presents a spectre for [Mr] Trump’s 2020 re-election campaign. Unless he can find some other source of fiscal or monetary stimulus, the economy is unlikely to be his friend. Can he persuade a Democratic-run Congress to sign up to a big spending bill on infrastructure? In theory yes. In practice, I very much doubt it. A Democratic House will have its hands full burying the Trump administration in subpoenas, televised hearings and possibly impeachment proceedings. It would take a Herculean feat of compartmentalisation for [Mr] Trump to negotiate bipartisan legislation while fending off multiple inquisitions into his malfeasance. Might he secure China’s economic surrender? Again, that is doubtful. Xi Jinping has as much, if not more, at stake politically as [Mr] Trump. His presidency-for-life might not survive a cave-in. What, then, would be the basis of [Mr] Trump’s re-election campaign?”
Coming full circle as far as my Outlook for 2019 is concerned, my answer to Mr Luce’s question was, back in September, and remains today that the basis for Mr Trump’s re-election campaign…
“…could all too easily turn out to be, in part at least, escalating the US’s trade war with China, ultimately counter-productive though this may be”.