Weekly Risk Outlook

Weekly Risk Outlook

Davos hosts World Economic Forum. Polish and EU leaders meet after EU starts investigation. China releases GDP figures. Brazil ponders raising interest rates. ECB makes first interest rate decision of 2016. All in the Weekly Risk Outlook.

Business leaders gather at World Economic Forum in Davos

On Wednesday, the World Economic Forum will host its annual summit in Davos, Switzerland. Co-chairs for this meeting will include the CEOs of GM, Microsoft, Hitachi, and Credit Suisse, as well as the general secretary of the International Trade Union Confederation. The conference, which is slated to extend to Saturday, marks a unique opportunity for business and government leaders to come together to discuss both emerging challenges as well as opportunities for the global economic system.

Included in this year’s forum schedule are a number of panels exploring the rise of innovative technologies and developments in renewable energy, which received a major boost with the Paris climate accord. In addition, both businesses and governments have increasingly had to grapple with innovative and disruptive technologies, on issues ranging from competitiveness to cybersecurity.

This year’s summit is expected to pay particularly close attention to emerging economies, with talks of China’s “new normal”, the rise of India, central banking in developing economies, and regional development in Eurasia slated to be major topics of discussion.

Additionally, this year’s forum is likely to serve as an informal coming back party for Argentina to the international economic community: Argentine President Mauricio Macri (as well as dissident Peronist and former presidential rival Sergio Massa) will be attending this year’s forum in an attempt to show that Argentina is “open for business” on world markets and looking to attract investment. An Argentine president hasn’t attended a Davos summit in over a dozen years, with both Kirchner presidents avoiding such summits largely for ideological reasons.

Polish president meets with EU officials as both sides look to ebb tensions

On Monday, Law & Justice President Andrzej Duda will meet with EU officials following last week’s European Commission meeting that took first steps toward investigating the newly inaugurated Polish government’s moves to alter Poland’s highest court as well as Polish state-controlled media.

Both sides have strong incentives to play nice; Poland was able to remain the only major EU country to avoid recession because its stability (as well as lower labor costs and relatively highly developed infrastructure) provided a beacon for foreign investment.

Additionally, Polish voters have not all taken to the PiS’s recent moves to alter the Constitutional Tribunal and media; many viewed the strong showing for the L&J party in recent elections less as a vote for a populist, right-leaning government and more as a protest against corruption in the Civic Coalition’s previous government. Any major shifts to the right that draw the ire of major trading partners that negatively impact Poland’s major export markets could turn voters away.

On the side of the EU, three major factors will likely constrain their capability to mete out harsh punishment against the new Polish government.

First, the lack of unity within the Commission regarding how to treat Poland scatters many of the Commission’s options moving forward (for example, a vote to suspend Poland’s voting rights would likely be vetoed by Hungary).

Second, the EU needs Poland to forge unity (or at least prevent further disunity) on issues like the migration crisis, relations with Russia and Ukraine, and the Greek bailout.

Finally, and probably most importantly, EU pushback may not work and turn out to ultimately be counterproductive. The last time the EU pushed hard against a right-wing populist government, in 1999/2000 with Austria’s far right FPO (under controversial leader Joerg Haider) working in coalition with the Austrian People’s Party, it largely ended in failure as the government dug in its heels and disunity among EU member states destroyed the united front against Austria.

Additionally, with the significant rise of Euroskepticism across Europe, now would not be an opportune time for the EU to make enemies.

China releases 2015 GDP data as markets express deepening skepticism

On Tuesday, China will release its 4th quarter GDP data, with many economists expecting growth to have been somewhere around 6.9%. Although such an estimate would be below China’s traditional growth rate target of 7%, the figure would nevertheless be an improvement on previous projections that followed China’s market downturn over the summer.

These numbers, however, may not tell the whole story. A boost in growth above projections would likely in large part be due to unexpectedly better growth figures in trade data. This boost in exports, however, did not reflect a growing or strengthening economy. Rather, it reflected a U.S. dollar that continued to strengthen relative to the renminbi in anticipation of (and later in reaction to) the Federal Reserve’s December decision to raise interest rates. Although most countries expect the dollar to strengthen over the course of the next year, which would help Chinese exports, many of China’s major export markets (the European Union, Latin America, and Japan to name a few) are likely to encounter serious economic headwinds that will depress consumer demand for Chinese goods.

Additionally, China’s repeated intervention in its stock market and its currency exchange system has raised questions among investors about the government-led growth model long championed by China.

Muddled, mishandled, or overly reactionary interventions in markets by the Chinese government will make investors wary to expand or begin investments in a country that seems economically unstable and has a potentially overly strong government hand trying (somewhat ineffectually) to steady the market. If China loses investor confidence as a safe and economically profitable place to invest in, the world’s second largest economy would need to prepare for a serious market adjustment.

Latin America’s largest economy may raise interest rates again given inflation and political turmoil

On Wednesday, the Central Bank of Brazil may raise interest rates again to 14.75%. Such a move would not be unprecedented (the Central Bank has raised interest rates at least 6 times over the course of the last 12 months), and would reflect growing concerns that inflation will continue to accelerate, and that shifting macroeconomic policies and political difficulties will make any attempt by Brazil to pull itself out of recession that much more difficult.

Last month, inflation stood at a dozen-year high of 10.67%, and is well above the target bracket for inflation of 3 to 6%. Economies in a downturn are hit almost exponentially harder by governments that are divided by partisan gridlock and unable to enact quick and decisive macroeconomic policies.

Brazil is increasingly looking like a case study of such a phenomenon: with the resignation of the more market-oriented finance minister Joaquim Levy in December following the fall of Brazil’s credit rating to junk, the fissures both within the Workers’ Party as well as with its coalition partner PMDB and opposition forces led by the PSDB have widened considerably.

This has made it difficult for businesses to determine the level of macroeconomic stability they can expect in the coming years (for example, will the country continue to pursue a policy of fiscal tightening? Will fear of runaway inflation, which has traditionally been one of the most difficult elements of Brazil’s economic landscape and was hard won over years of struggle, be sufficient to check fiscal stimulus?).

Adding the ongoing Petrobras investigation, which recently ensnared 3 former presidents and seems to have touched nearly every major figure in Brazilian politics, there’s a recipe for nearly boundless political risk.

ECB likely to keep rates low, but low inflation will continue to stoke concern

On Thursday, the European Central Bank will make its first interest rate decision for 2016. Although it is not expected to lower rates further or necessarily expand its stimulus following an increase at the end of 2015, attention has increasingly turned to low inflation figures.

Both the U.S. dollar and the euro are currently hovering around 0% inflation, with a significant degree of low inflation due to extremely depressed energy prices relative to previous years.

With oil prices now at around $30 a barrel, and in marked contrast to less than 2 years ago when prices were closer to $100 a barrel, consumers have reaped significant benefits but spending has stagnated. This problem is only likely to worsen in the coming weeks and months; Iran, relieved of sanctions with the implementation of the P5+1 nuclear deal, will see a potentially dramatic expansion of oil production. Other oil producing states, from Russia to Venezuela, have faced a spiral of increasing oil production as returns on oil become cheaper.

In previous instances of too-low oil prices, OPEC countries were traditionally relied upon to reduce production to drive up prices. But with internal dissent between Saudi Arabia and Iran strong, and previous moves by the Saudis to reduce production among both non-OPEC and OPEC states rebuffed, the consensus necessary to reduce consumption to boost prices is virtually non-existent.

For European, Japanese, and U.S. monetary policy makers, that means one of the key means to boost inflation, rising energy costs, will not be available to them. This will likely lead to caution on the part of the U.S. Federal Reserve on further raising interest rates, and may lead the ECB to further lower their own.

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 written by GRI analyst Brian Daigle.

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