by Bill O’Grady and Patrick Fearon-Hernandez, CFA | PDF
(N.B. Due to the Fourth of July holiday, our next geopolitical report will be published on July 18.)
As is our custom, we update our geopolitical outlook for the remainder of the year as the first half comes to a close. This report is less a series of predictions as it is a list of potential geopolitical issues that we believe will dominate the international landscape for the rest of the year. It is not designed to be exhaustive; instead, it focuses on the “big picture” conditions that we believe will affect policy and markets going forward. They are listed in order of importance.
Issue #1: The Russia-Ukraine War
Issue #2: Xi as China’s President for Life
Issue #3: The Global Food Crisis
Issue #4: Weather Disruptions
Issue #5: Latin American Politics
Issue #6: The U.S. Midterms
Issue #7: Fed Policy and the Dollar
Quick Hits: This section is a roundup of geopolitical issues we are watching that haven’t risen to the level of the concerns described above but should be monitored.
by Patrick Fearon-Hernandez, CFA | PDF
For more than a decade, we at Confluence have been tracking and writing about the waning commitment of the U.S. to its role as global hegemon. We’ve shown how U.S. retrenchment and protectionism have helped erode globalization. Factors like deregulation, falling transportation costs, improved technology, and easing geopolitical tensions following the end of the Cold War may have promoted political and economic integration for decades. Now, however, governments across the globe are erecting barriers to trade, investment, and migration, leaving authoritarian strongmen emboldened to assert themselves. The latest example of that has been Russian President Putin’s invasion of Ukraine.
Amid these developments, we’ve argued the world will fracture into at least two main political and economic blocs: a U.S.-led bloc consisting mostly of liberal democracies and a China-led bloc of mostly authoritarian states. This report discusses which nations are likely to join each bloc, which will merely lean toward one bloc or the other, and which may try to stay neutral. Based on our predicted makeup of each bloc, we describe their differing political, economic, and financial characteristics. As always, the analysis also includes ramifications for investors.
by Bill O’Grady | PDF
In mid-March, we wrote a report detailing the effects of financial sanctions on Russia. And now, about six weeks later, we are seeing the response from Russia. As we noted in our earlier report, Western sanctions on Russia were extensive. Although something similar was deployed against Iran, never before had such sanctions been used against a major country.
The initial response from the financial markets was swift; the ruble (RUB) plunged. However, over the past couple of weeks, the RUB/USD has recovered all of the initial losses. It should be noted that some of the recovery is due to capital controls as Moscow has made it very difficult to move money out of Russia. Exporters who acquire hard currency are required to turn 80% over to the Russian Central Bank. The bank also lifted interest rates to 20%, yet recently reduced its policy rate to 17%. But perhaps the most radical action the government has taken is to demand payment for energy in RUB.
In this report, we will begin with examining the concept of money and the complications that international trade creates, including a discussion of the reserve currency concept. Using this construct, we will apply it to the specific case of Russia. Our contention is that the dollar/Treasury reserve system is, at best, being tested, and at worst, unraveling. We will also include comments about emerging reserve currency blocs and conclude with potential market ramifications.
by Patrick Fearon-Hernandez, CFA | PDF
The Russia-Ukraine war has transformed the world in the blink of an eye. We think the war and its aftermath will reverse much of the economic globalization of recent decades and cleave the world into two or more blocs with only limited interplay. We believe sanctions on Russia will discourage many central banks from seeing the U.S. dollar as their preferred reserve currency. We see an isolated Russia being forced into an even tighter relationship with China, where it will be the junior partner.
Now that it’s easier to see the geopolitical and military threats from authoritarian leaders in China, Russia, and beyond, we believe the war has also ushered in a new era of high defense spending. We expect that countries around the world will now invest much more in national defense than they have in decades. This report examines the implications of higher defense spending within NATO and the potential ramifications for investors.