Weekly Risk Outlook

Weekly Risk Outlook
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COP21 begins in Paris. ECB sets interest rates. IMF discusses adding Yuan to SDR. Brazil releases poor Q3 growth figures. LNG summit in Italy explores potential. All in the Weekly Risk Outlook.

Global Climate Conference Begins in Paris

Today, Monday, the 2015 United Nations Climate Change Conference (UN COP21) will begin amid elevated security concerns following the November 13 Paris terrorist attacks.

The conference, scheduled to last until December 11, will include introductory remarks from President Hollande and UN Secretary General Ban Ki-Moon and is attended by the majority of world leaders as negotiations progress.

The negotiations between nations will begin with the Intended Nationally Determined Contributions (INDCs) submitted by both developed and developing nations as all parties seek to achieve a sustainable goal moving forward.

However, there are several key pressure points that will need to be carefully negotiated by member states to ensure any COP21 deal does not fail.

One conflict, largely between the European Union, major developing countries, and the United States, focuses on the legal status of the agreement for member states. The EU and Brazil (among others) are pushing for a legally binding and enforceable climate treaty.

The U.S. delegation, however, has pushed back strongly against any treaty as it is unlikely in the current political environment that a treaty would be able to secure a 2/3 majority vote in the U.S. Senate (as required by the US. Constitution, Article 2, § 2).

Another key issue revolves around how developing countries will secure the funding to support climate mitigation efforts. It is unlikely that developing countries will sign on to the agreement without firm funding commitments from major developed countries along the Copenhagen commitments.

In this regard, the U.S. may run into a legislative block: several Senate Republicans have pledged to use the upcoming budget negotiations to block the $3 billion in funding intended by the United States to developing countries.

 

ECB Sets Interest Rates Following Signs Draghi Will Push Cut

On Thursday, the European Central Bank will set interest rates as growth in the Eurozone remains sluggish.

In a speech to the European Parliament, ECB President Mario Draghi noted that inflation had weakened and that there were “clearly visible” risks to the Eurozone economy.

The ECB is also likely to expand its $1.2 trillion QE program. Lowering interest rates further into negative territory and expanding the QE program will likely reduce the value of the euro against the U.S. dollar, a trajectory that will be accelerated if the U.S. Federal Reserve chooses to raise U.S. interest rates in two weeks (which Fed Chair Yellen has indicated is likely).

Whether or not these moves by the ECB will be sufficient to move the Eurozone back up is difficult to say. Falling growth rates from Brazil and Russia to China and Canada, as well as a fall in demand, will all make it very difficult for the ECB to move the Eurozone out of its sluggish growth and inflation rates.

 

IMF Likely to Add Yuan to Special Drawing Rights

The International Monetary Fund’s executive board will meet today to decide whether to place China’s yuan among the yen, pound, euro and U.S. dollar in its currency basket for the IMF’s Special Drawing Rights.

After Managing Director Christine Lagarde and the IMF’s technical staff expressed support for adding the yuan to the IMF’s currency basket, it appears likely that the executive board will support the expansion.

Although the addition of the yuan to the SDR would represent a significant symbolic coup for the emergence of China as a major economic player (the designation of a currency for the IMF basket is based on a currency being widely used for international transactions and traded in foreign exchange markets), its practical significance could be muted by recurrent concerns that China’s intervention in its currency to address domestic policy concerns and prevent it from being a truly floated global currency.

Other concerns that could prevent the elevated status of the yuan include China’s slowing economy and the rise of the U.S. dollar, which will likely impact a wide array of developing country currencies.

However, others have argued that China’s currency inclusion in the IMF’s SDR could help lock in economic reforms undertaken by the Chinese government on its accession to the WTO.

 

Brazil’s Growth Likely to Reveal Deeper Recession than Forecast

On Tuesday, the Brazilian Ministry of Finance will likely reveal that Brazil’s economy contracted by at least 3% over the past year, and is likely to fall an additional 2% next year.

If these numbers are borne out, it would mark the first time in over 60 years that Brazil’s economy experienced such a downturn. Although the Brazilian Central Bank voted last week to maintain its interest rate at 14.25%, two central bank voting members dissented in favor of raising the rate to 14.75%.

The increasingly complex dynamics of rising inflation and interest rates, the rise of the U.S. dollar against the real (making servicing debts denominated in U.S. dollars increasingly expensive, as Petrobras is learning), falling commodity prices, and reduced growth prospects are all likely to contribute to a continued poor outlook for the Brazilian economy and a more difficult path out for Brazilian policymakers.

One unanswered question for Brazil’s economy is the impact Argentina’s president-elect Mauricio Macri will have on cross-border trade between the two countries.

Argentina’s heavy export controls have limited trade and growth between Brazil and Argentina, and should the Macri administration move to officially devalue the Argentine peso, this could further hamper Brazil’s growth by making Brazilian exports less competitive.

 

LNG Summit in Italy Will Explore Growth Potential

On Wednesday, the World LNG Summit will take place in Rome. Speakers from the United States, Africa, the Middle East, and Europe will be in attendance.

The natural gas market, similar to the oil market, has experienced a precipitous decline in prices, and suppliers have seen a glut in supply as demand either atrophies or falls.

In Japan, demand for LNG has fallen significantly over the course of the year, which has led in part to the overall fall in LNG prices in Asia.

China has moved recently to staunch the fall in LNG prices in Asia by reducing natural gas prices for commercial users, but as projects for LNG are often tied to the price of crude, this effort may have limited returns so long as oil prices remain low.

A number of other challenges, including noncompetitive prices relative to coal and in some places oil in key markets, reduced demand for new contracts, and issues with Australian LNG projects, will also likely be discussed at the LNG Summit as producers ponder the short and medium-term prospects for the major energy market.

 

The GRI Weekly Risk Outlook (WRO) provides analytical foresight on the economic consequences of upcoming political developments. Covering a number of future occurrences across the globe, the WRO presents a series of potential upside/downside risks, shedding light on how political decisions affect economic outcomes.

The Weekly Risk Outlook was produced by GRI analyst Brian Daigle.

Categories: International, Politics

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