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Video17 Jan 2016

Global Political Risk

The New Convergence Between Geopolitical and Vox Populi Risks, and Why It Matters
2016 has begun, as 2015 ended, amid a significant worsening of the global political climate and along with that, considerable volatility in financial markets. Investors and businesses are increasingly aware of the need to understand the drivers and the implications of a greater level of event risk exacerbated by shifting social patterns.

Tina Fordham, Citi's Global Chief Political Analyst, has already warned that the latest events may mark a turning point in the political landscape as rising geopolitical tensions and shifting socio-political trends converge in an increasingly interconnected world. In this publication, Tina and co-author Jan Techau, Director of European think tank Carnegie Europe, explain how weakened global elites and fast evolving social trends have created an increasingly unstable political environment that threatens to bring unprecedented commercial challenges on a global scale. There is an increasing likelihood that new transmission mechanisms are evolving that could lead to political risk having an impact on economic forecasting models, changing the way that companies do business and driving a secular, or even structural, increase in risk premia in financial markets. Until now, financial markets have taken a relatively sanguine view of political events, treating them as regionalized and idiosyncratic. However political risk can quickly and meaningfully alter return expectations across asset markets where transmission mechanisms are established in economic channels. Political events and social trends are becoming increasingly interconnected; links can easily be made between tensions in the Middle East, terrorist attacks around the world and the migration crisis, between migration and European politics, and between tensions in Europe and politics in the U.K. With shifting political sands in the U.S. creating a vacuum in global governance, there is an increasing risk that a negative feedback loop is forming as previously comfortable sectors of society feel increasingly vulnerable and less financially secure.   Hitherto, geopolitical events have largely been addressed through diplomatic channels but, as Tina and Jan point out, diplomacy is ineffective against a rising sentiment of injustice and inequality among increasingly diverse social groupings. The result is an increased incidence, on one side, of non-diplomatic measures such as sanctions, protectionism, aggressive regulation, border disputes and armed conflict, and on the other of anti-establishment sentiment, protests, violent demonstration and terrorist activity. All of these can deliver a direct economic cost that could be changing the business and investment landscape. There are several channels through which political events could become a driver of financial markets: Sharply higher or lower commodity prices are surely one. Sanctions are another as they will normally have an impact on the economic prospects of an affected country. There may be an offset to this; when exports from a sanctioned country fall, there is likely to be a substitution effect in another producing economy. Overall, however, a combination of more sanctions and increased protectionism is likely to result in lower levels of trade and this, with reduced comparative advantages in production, is likely to weigh on global growth and commerce. One of the main factors insulating markets from geopolitical risk has been abundant liquidity provision by central banks. As the Fed begins to raise rates, that support will begin to wane. For most of 2015 markets were transfixed by two main drivers; Fed policy and China's economic outlook. 2016 and beyond may prove to be the era in which politics rather than economics comes to the fore. To address this, we have brought together leading experts on geopolitical and socio-economic risks (Tina Fordham and Jan Techau) energy (Ed Morse) and economics (Ebrahim Rahbari) who believe he contours of a new post-Cold War, post-Lehman paradigm are emerging. If they are right, or even partly right, and these changes are structural, we may be entering a new paradigm, where policy-makers, including Central Banks, have less power to mitigate risks. This suggests a whole host of previously assured assumptions could be in the process of becoming obsolete.

Click here to view the report in full.
Global Politics

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