DM Europe
Highlights The U.S. and China are moving toward formalizing a trade ceasefire that reduces geopolitical risk in the near term. The risk of a no-deal Brexit is finished – removing a major downside to European assets. Spanish elections reinforce our narrative of general European political stability. Go long 10-year Italian BTPs / short 10-year Spanish bonos for a trade. Geopolitical risks will remain elevated in Turkey, rise in Russia, but remain subdued in Brazil. A post-mortem of Canada’s election suggests upside to fiscal spending but further downside to energy sector investment over the short to medium term. Feature After a brief spike in trade war-related geopolitical risk just prior to the resumption of U.S.-China negotiations, President Trump staged a tactical retreat in the trade war. Chart 1Proxy For Trade War Shows Falling Risk Negotiating in Washington, President Trump personally visited the top Chinese negotiator Liu He and the two sides announced an informal “phase one deal” to reverse the summer’s escalation in tensions: China will buy $40-$50 billion in U.S. agricultural goods while the U.S. will delay the October 15 tariff hike. More difficult issues – forced tech transfer, intellectual property theft, industrial subsidies – were punted to later. The RMB is up 0.7% and our own measures of trade war-related risk have dropped off sharply (Chart 1). We think these indicators will be confirmed and Trump’s retreat will continue – as long as he has a chance to save the 2020 economic outlook and his reelection campaign. Odds are low that Trump will be removed from office by a Republican-controlled senate – the looming election provides the republic with an obvious recourse for Trump’s alleged misdeeds. However, Trump’s approval rating is headed south. While it is around the same level as President Obama’s at this point in his first term, Obama’s started a steep and steady rise around now and ended above 50% for the election, a level that is difficult to foresee for Trump (Chart 2). So Trump desperately needs an economic boost and a policy victory to push up his numbers. Short of passing the USMCA, which is in the hands of the House Democrats, a deal with China is the only way to get a major economic and political win at the same time. Hence the odds of Presidents Trump and Xi actually signing some kind of agreement are the highest they have been since April (when we had them pegged at 50/50). Trump will have to delay the December 15 tariff hike and probably roll back some of the tariffs over next year as continuing talks “make progress,” though we doubt he will remove restrictions on tech companies like Huawei. Still, we strongly believe that what is coming is a détente rather than the conclusion of the Sino-American rivalry crowned with a Bilateral Trade Agreement. Strategic tensions are rising on a secular basis between the two countries. These tensions could still nix Trump’s flagrantly short-term deal-making, and they virtually ensure that some form of trade war will resume in 2021 or 2022, if indeed a ceasefire is maintained in 2020. Both sides are willing to reduce immediate economic pain but neither side wants to lose face politically. Trump will not forge a “grand compromise.” Our highest conviction view all along has been – and remains – that Trump will not forge a “grand compromise” ushering in a new period of U.S.-China economic reengagement in the medium or long term. China’s compliance, its implementation of structural changes, will be slow or lacking and difficult to verify at least until the 2020 verdict is in. This means policy uncertainty will linger and business confidence and capex intentions will only improve on the margin, not skyrocket upward (Chart 3). Chart 2Trump Needs A Policy Win And Economic Boost Chart 3Sentiment Will Improve ... Somewhat The problem for bullish investors is that even if global trade uncertainty falls, and the dollar’s strength eases, fear will shift from geopolitics to politics, and from international equities to American equities (Chart 4). Trump, hit by impeachment and an explosive reaction to his Syria policy, is entering into dangerous territory for the 2020 race. Trump’s domestic weakness threatens imminent equity volatility for two reasons. Chart 4American Outperformance Falls With Trade Tensions Chart 5Democratic Win In 2020 Is Market-Negative First, if Trump’s approval rating falls below today’s 42%, investors will begin pricing a Democratic victory in 2020, i.e. higher domestic policy uncertainty, higher taxes, and the re-regulation of the American economy (Chart 5). This re-rating may be temporarily delayed or mitigated by the fact that former Vice President Joe Biden is still leading the Democratic Party’s primary election race. Biden is a known quantity whose policies would simply restore the Obama-era status quo, which is only marginally market-negative. Contrary to our expectations Biden's polling has not broken down due to accusations of foul play in Ukraine and China. Nevertheless, Senator Elizabeth Warren will gradually suck votes away from fellow progressive Senator Bernie Sanders and in doing so remain neck-and-neck with Biden (Chart 6). When and if she pulls ahead of Biden, markets face a much greater negative catalyst. (Yes, she is also capable of beating Trump, especially if his polling remains as weak as it is.) Chart 6Warren Will Rise To Front-Runner Status With Biden Second, if Trump becomes a “lame duck” he will eventually reverse the trade retreat above and turn into a loose cannon in his final months in office. Right now we see a decline in geopolitical risk, but if the economy fails to rebound or the China ceasefire offers little support, then Trump will at some point conclude that his only chance at reelection is to double down on his confrontation with America’s enemies and run as a “war president.” A cold war crisis with China, or a military confrontation with Iran (or North Korea, Venezuela, or some unexpected target) could occur. But since September we have been confirmed in believing that Trump is trying to be the dealmaker one last time before any shift to the war president. Bottom Line: The “phase one” trade deal is really just a short-term ceasefire. Assuming it is signed by Trump and Xi, it suggests no increase in tariffs and some tariff rollback next year. However, as recessionary fears fade, and if Trump’s reelection chances stabilize, U.S.-China tensions on a range of issues will revive – and there is no getting around the longer-term conflict between the two powers. For this and other reasons, we remain strategically short RMB-USD, as the flimsy ceasefire will only briefly see RMB appreciation. BoJo's Brexit Bluff Is Finished Our U.K. indicator captured a sharp decline in political risk in the past two weeks and our continental European indicators mirrored this move (Chart 7). The risk that the U.K. would fall out of the EU without a withdrawal agreement has collapsed even further than in September, when parliament rejected Prime Minister Boris Johnson’s no-deal gambit and we went long GBP-USD. We have since added a long GBP-JPY trade. Chart 7Collapse In No-Deal Risk Will Echo Across Europe Chart 8Unlikely To See Another Tory/Brexit Rally Like This The risk of “no deal” is the only reason to care about Brexit from a macro point of view, as the difference between “soft Brexit” and “no Brexit” is not globally relevant. What matters is the threat of a supply-side shock to Europe when it is already on the verge of recession. With this risk removed, sentiment can begin to recover (and Trump’s trade retreat also confirms our base case that he will not impose tariffs on European cars on November 14). Since Brexit was the only major remaining European political risk, European policy uncertainty will continue to fall. The Halloween deadline was averted because the EU, on the brink of recession, offered a surprising concession to Johnson, enabling him to agree to a deal and put it up for a vote in parliament. The deal consists of keeping Northern Ireland in the European Customs Union but not the whole of the U.K., effectively drawing a new soft border at the Irish Sea. The bill passed the second reading but parliament paused before finalizing it, rejecting Johnson’s rapid three-day time table. The takeaway is that even if an impending election returns Johnson to power, he will seek to pass his deal rather than pull the U.K. out without a deal. This further lowers the odds of a no-deal Brexit as it illuminates Johnson's preferences, which are normally hidden from objective analysis. True, there is a chance that the no-deal option will reemerge if Johnson’s deal totally collapses due to parliamentary amendments, or if the U.K. and EU have failed to agree to a future relationship by the end of the transition period on December 31, 2020 (which can be extended until the end of 2022). However, the chance is well below the 30% which we deemed as the peak risk of no-deal back in August. Johnson created the most credible threat of a no-deal exit that we are likely to see in our lifetimes – a government with authority over foreign policy determined to execute the outcome of a popular referendum – and yet parliament stopped it dead in its tracks. Johnson does not want a no-deal recession and his successors will not want one either. After all, the support for Brexit and for the Tories has generally declined since the referendum, and the Tories are making a comeback on the prospect of an orderly Brexit (Chart 8). All eyes will now turn toward the impending election. Opinion polls still show that Johnson is likely to be returned to power (Chart 9). The Tories have a prospect of engrossing the pro-Brexit vote while the anti-Brexit opposition stands divided. No-deal risk only reemerges if the Conservatives are returned to power with another weak coalition that paralyzes parliament. Chart 9Tory Comeback As BoJo Gets A Deal Chart 10Brexit Means Greater Fiscal Policy Whatever the election result, we maintain our long-held position that Brexit portends greater fiscal largesse (Chart 10). The agitated swath of England that drove the referendum result will not be assuaged by leaving the European Union – the rewards of Brexit are not material but philosophical, so material grievances will return. Voter frustration will rotate from the EU to domestic political elites. Voters will demand more government support for social concerns. Johnson’s own government confirms this point through its budget proposals. A Labour-led government would oversee an even more dramatic fiscal shift. Our GeoRisk indicator will fall on Brexit improvements but the question of the election and next government will ensure it does not fall too far. Our long GBP trades are tactical and we expect volatility to remain elevated. But the greatest risk, of no deal, is finished, so it does make sense for investors with a long time horizon to go strategically long the pound. The greatest risk, of a no deal Brexit, is finished. Bottom Line: Brexit posed a risk to the global economy only insofar as it proved disorderly. A withdrawal agreement by definition smooths the process. Continental Europe will not suffer a further shock to net exports. The Brexit contribution to global policy uncertainty will abate. The pound will rise against the euro and yen and even against the dollar as long as Trump’s trade retreat continues. Spain: Further Evidence Of European Stability We have long argued that the majority of Catalans do not want independence, but rather a renegotiation of the region's relationship with Spain (Chart 11). This month’s protests in Barcelona following the Catalan independence leaders’ sentencing are at the lower historical range in terms of size – protest participation peaked in 2015 along with support for independence (Table 1). Table 1October Catalan Protests Unimpressive Our Spanish risk indicator is showing a decline in political risk (Chart 12). However, we believe that this fall is slightly overstated. While the Catalan independence movement is losing its momentum, the ongoing protests are having an impact on seat projections for the upcoming election. Chart 11Catalonians Not Demanding Independence Chart 12Right-Wing Win Could Surprise Market, But No Worries Since the April election, the right-wing bloc of the People’s Party, Ciudadanos, and Vox has been gaining in the seat projections at the expense of the Socialist Party and Podemos. Over the course of the protests, the left-wing parties’ lead over the right-wing parties has narrowed from seven seats to one (Chart 13). If this momentum continues, a change of government from left-wing to right-wing becomes likely. However, a right-wing government is not a market-negative outcome, and any increase in risk on this sort of election surprise would be short-lived. The People’s Party has moderated its message and focused on the economy. Besides pledging to limit the personal tax rate to 40% and corporate tax rate to 20%, the People’s Party platform supports innovation, R&D spending, and startups. The party is promising tax breaks and easier immigration rules to firms and employees pursuing these objectives. Chart 13Spanish Right-Wing Parties Narrow Gap With Left Another outcome of the election would be a governing deal between PSOE and Podemos, along with case-by-case support from Ciudadanos. After a shift to the right lost Ciudadanos 5% in support since the April election, leader Albert Rivera announced in early October that he would be lifting the “veto” on working with the Socialist Party. If the right-wing parties fall short of a majority, then Rivera would be open to talks with Socialist leader Pedro Sanchez. A governing deal between PSOE, Podemos, and Ciudadanos would have 175 seats, as of the latest projections, which is just one seat short of a majority. As we go to press, this is the only outcome that would end Spain’s current political gridlock, and would therefore be the most market-positive outcome. Bottom Line: Despite having a fourth election in as many years, Spanish political risk is contained. This is reinforced by a relatively politically stable backdrop in continental Europe, and marginally positive developments in the U.K. and on the trade front. We remain long European versus U.S. technology, and long EU versus Chinese equities. We will also be looking to go long EUR/USD when and if the global hard data turn. Following our European Investment Strategy, we recommend going long 10-year Italian BTPs / short 10-year Spanish bonos for a trade. Turkey, Brazil, And Russia Chart 14Turkish Risk Will Rise Despite 'Ceasefire' Turkey’s political risk skyrocketed upward after we issued our warning in September (Chart 14). We maintain that the Trump-Erdogan personal relationship is not a basis for optimism regarding Turkey’s evading U.S. sanctions. Both chambers of the U.S. Congress are preparing a more stringent set of sanctions, focusing on the Turkish military, in the wake of Trump’s decision to withdraw U.S. forces from northeast Syria. At a time when Trump needs allies in the senate to defend him against eventual impeachment articles, he is not likely to veto and risk an override. Moreover, Turkey’s military incursion into Syria, which may wax and wane, stems from economic and political weakness at home and will eventually exacerbate that weakness by fueling the growing opposition to Erdogan’s administration and requiring more unorthodox monetary and fiscal accommodation. It reinforces our bearish outlook on Turkish lira and assets. Chart 15Brazilian Risk Will Not Re-Test 2018 Highs Brazil’s political risk has rebounded (Chart 15). The Senate has virtually passed the pension reform bill, as expected, which raises the official retirement age for men and women to 65 and 63 respectively. This will generate upwards of 800 billion Brazilian real in savings to improve the public debt profile. Of course, the country will still run primary deficits and thus the public debt-to-GDP ratio will still rise. Now the question shifts to President Jair Bolsonaro and his governing coalition. Bolsonaro’s approval rating has ticked up as we expected (Chart 16). If this continues then it is bullish for Brazil because it suggests that he will be able to keep his coalition together. But investors should not get ahead of themselves. Bolsonaro is not an inherently pro-market leader, there is no guarantee that he will remain disciplined in pursuing pro-productivity reforms, and there is a substantial risk that his coalition will fray without pension reform as a shared goal (at least until markets riot and push the coalition back together). Therefore we expect political risk to abate only temporarily, if at all, before new trouble emerges. Furthermore, if reform momentum wanes next year, then Brazil’s reform story as a whole will falter, since electoral considerations emerge in 2021-22. Hence it will be important to verify that policymakers make progress on reforms to tax and trade policy early next year. Our Russian geopolitical risk indicator is also lifting off of its bottom (see Appendix). This makes sense given Russia’s expanding strategic role (particularly in the Middle East), its domestic political troubles, and the risks of the U.S. election. The latter is especially significant given the risk (not our base case, however) that a Democratic administration could take a significantly more aggressive posture toward Russia. Political risk in Turkey and Russia will continue to rise. Bottom Line: Political risk in Turkey and Russia will continue to rise. Russia is a candidate for a “black swan” event, given the eerie quiet that has prevailed as Putin devotes his fourth term to reducing domestic political instability. Brazil, on the other hand, has a 12-month window in which reform momentum can be reinforced, reducing whatever spike in risk occurs in the aftermath of the ruling coalition’s completion of pension reform. Canada: Election Post-Mortem Prime Minister Justin Trudeau returned to power at the head of a minority government in Canada’s federal election (Chart 17). The New Democratic Party (NDP) lost 15 seats from the last election, but will have a greater role in parliament as the Liberals will need its support to pass key agenda items (and a formal governing coalition is possible). The NDP’s result would have been even worse if not for its last-minute surge in the polls after the election debates and Trudeau’s “blackface” scandal. Chart 17Liberals Need The New Democrats Now The Conservative Party won the popular vote but only 121 seats in parliament, leaving the western provinces of Alberta and Saskatchewan aggrieved. The Bloc Québécois, the Quebec nationalist party, gained 22 seats to become the third-largest party in the House. Energy investment faces headwinds in the near-term. The Liberal Party will face resistance from the Left over the Trans Mountain pipeline. Trudeau will not necessarily have to sacrifice the pipeline to appease the NDP. He may be able to work with Conservatives to advance the pipeline while working with the NDP on the rest of his agenda. But on the whole the election result is the worst-case scenario for the oil sector and political questions will have to be resolved before Canada can take advantage of its position as a heavy crude producer near the U.S. Gulf refineries in an era in which Venezuela is collapsing and Saudi Arabia is exposed to geopolitical risk and attacks. More broadly, the Liberals will continue to endorse a more expansive fiscal policy than expected, given Canada’s low budget deficits and the need to prevent minor parties from eating away at the Liberal Party’s seat count in future. Bottom Line: The Liberal Party failed to maintain its single-party majority. Trudeau’s reliance on left-wing parties in parliament may prove market-negative for the Canadian energy sector, though that is not a forgone conclusion. Over the longer term the sector has a brighter future. Matt Gertken Geopolitical Strategist mattg@bcaresearch.com Ekaterina Shtrevensky Research Analyst ekaterinas@bcaresearch.com Appendix GeoRisk Indicator U.K.: GeoRisk Indicator France: GeoRisk Indicator Germany: GeoRisk Indicator Spain: GeoRisk Indicator Italy: GeoRisk Indicator Canada: GeoRisk Indicator Russia: GeoRisk Indicator Turkey: GeoRisk Indicator Brazil: GeoRisk Indicator Taiwan: GeoRisk Indicator Korea: GeoRisk Indicator What's On The Geopolitical Radar? Section III: Geopolitical Calendar
Highlights Geopolitical risks are starting to abate as a result of material constraints influencing policymakers. China needs to ensure its economy bottoms and a debt-deflationary tendency does not take hold. President Trump needs to avoid further economic deterioration arising from the trade war. The U.K. is looking to prevent a recession induced by leaving the EU without an agreement. Iran and the risk of an oil price shock is the outstanding geopolitical tail risk. Feature Readers of BCA’s Geopolitical Strategy know that what defines our research is our analytical framework – specifically the theory of constraints. Chart 1The Electoral College – An Overlooked Constraint The theory holds that policymakers are trapped by the pressures of their office, their nation’s global position, and the stream of events. These pressures emerge from the material world that we inhabit and as such are measurable. If a leader lacks popular approval, cannot command a majority in the legislature, rides atop a sinking economy, or suffers under stronger or smarter foreign enemies, then his policy preferences will be compromised. He will have to change his preferences to accommodate the constraints, rather than the other way around. Case in point is the U.S. electoral college: it proved an insurmountable political constraint on the Democratic Party in 2016. The college is intended to restrain direct democracy or popular passions; it also restrains the concentration of regional power. In 2012, Barack Obama won a larger share of the electoral college than the popular vote, while in 2016 Hillary Clinton won a smaller share (Chart 1). Clinton’s lack of appeal in the industrial Midwest turned the college and deprived her of the prize. The rest is history. In this report we highlight five key constraints that will shape the direction of the major geopolitical risks in the fourth quarter. We recommend investors remain tactically cautious on risk assets, although we have not yet extended this recommendation to the cyclical, 12-month time frame. China’s Policy: The Debt-Deflation Constraint We have a solid record of pessimism regarding Chinese President Xi Jinping’s willingness and ability to stimulate the economy – but even we were surprised by his tenacity this year. His administration’s effort to contain leverage, while still stimulating the economy, has prevented a quick rebound in the global manufacturing cycle. The constraint limiting this approach is the need to avoid a debt-deflation spiral. This is a condition in which households and firms become pessimistic about the future and cut back their spending and borrowing. The general price level falls and drives up real debt burdens, which motivates further cutbacks. A classic example is Japan, which saw a property bubble burst, destroying corporate balance sheets and forcing the country into a long phase of paying down debt amid falling prices. China has not seen its property bubble burst yet. Prices have continued to rise despite the recent pause in the non-financial debt build-up (Chart 2). Looser monetary and fiscal policy have sustained this precarious balance. But the result is a tug-of-war between the government and the private sector. If the government miscalculates, and the asset bubble bursts, then it will be extremely difficult for the government to change the mindset of households and companies bent on paying down debt. It will be too late to avoid the vicious spiral that Japan experienced – with the critical proviso that Chinese people are less wealthy than the Japanese in 1990 and the country’s political system is less flexible. A Japan-sized economic problem would lead to a China-sized political problem. This is why the recent drop in Chinese producer prices below zero is a worrisome sign (Chart 3). Policymakers have loosened monetary and fiscal policy incrementally since July 2018 and they are signaling that they will continue to do so. This is particularly likely in an environment in which trade tensions are reduced but remain fundamentally unresolved – which is our base case. Chart 2China's Property Bubble Intact Chart 3China's Constraint Is Debt-Deflation Are policymakers aware of this constraint? Absolutely. If the trade talks collapse, or the global economy slumps regardless, then China will have to stimulate more aggressively. Xi Jinping is not truly a Chairman Mao, willing to impose extreme austerity. He oversaw the 2015-16 stimulus and would do it again if he came face to face with the debt-deflation constraint. Is China still capable of stimulating? High debt levels, the reassertion of centralized state power, and the trade war have all rendered traditional stimulus levers less effective by dampening animal spirits. Yet policymakers are visibly “riding the brake,” so they can remove restraints and increase reflation if necessary. Most obviously, authorities can inject larger fiscal stimulus. They have insisted that they will prevent easy monetary and credit policies from feeding into property prices – and this could change. They could also pick up the pace when it comes to reducing average bank lending rates for small and medium-sized businesses.1 In short, stimulus is less effective, but the government is also preferring to save dry powder. This preference will be thrown by the wayside if it hits the critical constraint. The implication is that Chinese stimulus will continue to pick up over a cyclical, 12-month horizon. There is impetus to reduce trade tensions with the U.S., discussed below, but a lack of final resolution will ensure that policy tightening is not called for. Bottom Line: China’s chief economic constraint is a debt-deflation trap. This would engender long-term economic difficulties that would eventually translate into political difficulties for Communist Party rule. If a trade deal is reached, it is unlikely alone to require a shift to tighter policy. If the trade talks collapse, stimulus will overshoot to the upside. Trade War: The Electoral Constraint The U.S. and China are holding the thirteenth round of trade negotiations this week after a summer replete with punitive measures, threats, and failed restarts. Tensions spiked just ahead of the talks, as expected. Immediately thereafter President Trump declared he will meet with Chinese negotiators to give a boost to the process and reassure the markets.2 Trump’s major constraint in waging the trade war is economic, not political. Americans are generally sympathetic to his pressure campaign against China. Public opinion polls show that a strong majority believes it is necessary to confront China even though the bulk of the economic pain will be borne by consumers themselves (Chart 4). Yet Americans could lose faith in Trump’s approach once the economic pain fully materializes. Critically, the decline in wage growth that is occurring as a result of the global and manufacturing slowdown is concentrated in the states that are most likely to swing the 2020 election, e.g. the “purple” or battleground states (Chart 5). Chart 4Americans To Confront China Despite The Costs? Chart 5Trump Faces Pressure To Stage A Tactical Trade Retreat Furthermore, a rise in unemployment, which is implied by the recent decline in the University of Michigan’s survey of consumer confidence regarding the purchase of large household goods, would devastate voters’ willingness to give Trump’s tariff strategy the benefit of the doubt (Chart 6). Wisconsin and Pennsylvania, two critical states, have seen a net loss of manufacturing jobs on the year. The fear of an uptick in U.S. unemployment will prevent Trump from escalating the trade war. An uptick in unemployment would be a major constraint on Trump’s trade war – he cannot escalate further until the economy has stabilized. And that may very well require tariff rollback while trade talks “make progress.” We expect that Trump is willing to do this in the interest of staying in power. As highlighted above, the Xi administration is not without its own constraints. Our proxies for China’s marginal propensity to consume show that Chinese animal spirits are still vulnerable, particularly on the household side, which has not responded to stimulus thus far (Chart 7). Since this constraint is less immediate than Trump’s election date, Xi cannot be expected to capitulate to Trump’s biggest demands. Hence a ceasefire or détente is more likely than a full bilateral trade agreement. Chart 6Waning Consumer Confidence On Big Ticket Items Foreshadows Rise In Unemployment Trump’s electoral constraint also suggests that he needs to remove trade risks such as car tariffs on Europe and Japan (which we expect he will do). We have been optimistic on the passage of the USMCA trade deal but impeachment puts this forecast in jeopardy. Chart 7China's Trade War Constraint? Animal Spirits Bottom Line: Trump will stage a tactical retreat on trade in order to soften the negative impact on the economy and reduce the chances of a recession prior to the November 3, 2020 election. China’s economic constraints are less immediate and it is unlikely to make major structural concessions. Hence we expect a ceasefire that temporarily reduces tensions and boosts sentiment rather than a bilateral trade agreement that initiates a fundamental deepening of U.S.-China economic engagement. U.S. Policy: The Economic Constraint The 2020 U.S. election is a critical political risk both because of the volatility it will engender and because of what we see as a 45% chance that it will lead to a change in the ruling party governing the world’s largest economy. Will Trump be the candidate? Yes. If Trump’s approval among Republicans breaks beneath the lows plumbed during the Charlottesville incident in 2017 (Chart 8A), then Trump has an impeachment problem, but otherwise he is safe from removal. Judging by the Republican-leaning pollster Rasmussen, which should reflect the party’s mood, Trump’s approval rating has not broken beneath its floor and may already be bouncing back from the initial hit of the impeachment inquiry (Chart 8B). The rise in support for impeachment and removal in opinion polls is notable, but it is also along party lines and will fade if the Democrats are seen as dragging on the process or trying to circumvent an election that is just around the corner. Chart 8ARepublican Opinion Precludes Trump’s Removal Chart 8BRepublican-Leaning Pollster Shows Support Holding Thus Far How will all of this bear on the 2020 election? Turnout will be high so everything depends on which side will be more passionate. A critical factor will be the Democratic nominee. Former Vice President Joe Biden, the establishment pick, has broken beneath his floor in the polling. His rambling debate performances have reinforced the narrative that he is too old, while the impeachment of Trump will fuel counteraccusations of corruption that will detract from Biden’s greatest asset: his electability. According to a Harvard-Harris poll from late September, 61% of voters believe it was inappropriate for Biden to withhold aid from Ukraine to encourage the firing of a Ukrainian prosecutor even when the polling question makes no mention of any connection with Biden’s son’s business interest there. Moreover, 77% believe it is inappropriate that Biden’s son Hunter traveled with his father to China while soliciting investments there. With Vermont Senator Bernie Sanders’s candidacy now defunct as a result of his heart attack and old age, Elizabeth Warren, the progressive senator from Massachusetts, will become the indisputable front runner (which she is not yet). In the fourth primary debate on October 15, she will face attacks from all sides reflecting this new status. Given her debate performances thus far, she will sustain the heightened scrutiny and come out stronger. This is not to say that Warren is already the Democratic candidate. Biden is still polling like a traditional Democratic primary front runner (Chart 9), while Warren has some clear weaknesses in electability, as reflected in her smaller lead over Trump in head-to-head polls in swing states. Nevertheless Warren is likely to become the front runner. Chart 9Biden Polling About Average Relative To Previous Democratic Primary Front Runners The recession call remains the U.S. election call. Two further considerations: Impeachment and removal of President Trump ensure a Democratic victory. There are hopes in some quarters that President Trump could be impeached and removed and yet his Vice President Mike Pence could go on to win the 2020 election, preserving the pro-business policy status quo. The problem with this logic is that Trump cannot be removed unless Republican opinion shifts. This will require an earthquake as a result of some wrongdoing by Trump. Such an earthquake will blacken Pence’s and the GOP’s name and render them toxic in the general election. Not to mention that Pence’s only act as president in the brief interim would likely be to pardon Trump and his accomplices. He would suffer Gerald Ford’s fate in 1976. Which means that a significant slide in Trump’s approval among Republicans will translate to higher odds of a Democratic win in 2020 and hence higher taxes and regulation, i.e. a hit to corporate earnings expectations. We expect this approval to hold up, but the market can sell off anyway because … The market is overrating the Senate as a check on Warren in the event she wins the White House. It is true that relative to Biden, Warren is less likely to carry the Senate. Democrats need to retain their Senate seat in Alabama, while capturing Maine, Colorado, and Arizona (or Georgia) in addition to the White House in order to control the Senate. Biden is more competitive in Arizona and Georgia than Warren. But this is a flimsy basis to feel reassured that a Warren presidency will be constrained. In fact, it is very difficult to unseat a sitting president. If the Democrats can muster enough votes to kick out an incumbent and elect an outspoken left-wing progressive from the northeast, they most likely will have mustered enough votes to take the Senate as well. For instance, unemployment could be rising or Trump’s risky foreign policy could have backfired. Chart 10Business Sentiment Threatens Trump Re-Election In our estimation the Democrats have about a 45% chance of winning the presidency, and Warren does not significantly reduce this chance. The resilient U.S. economy is Trump’s base case for success. But Trump’s trade policy and the global slowdown are rapidly eating away at the prospect that voters see improvement (Chart 10). This speaks to the constraint driving a ceasefire with China above, but it also speaks to the broader probability of policy continuity in the U.S. As Warren’s path to the White House widens, there is a clear basis for equities to sell off in the near term. Bottom Line: Trump’s approval among Republicans is a constraint on his removal via impeachment. But the status of the economy is the greater constraint. The recession call remains the election call. While we expect downside in the near term, we are still constructive on U.S. equities on a cyclical basis. War With Iran: The Oil Price Constraint The Senate will remain President Trump’s bulwark amid impeachment, notwithstanding the controversial news that Trump is moving forward with the withdrawal of troops from Syria, specifically from the so-called “safe zone” agreed with Turkey, giving Ankara license to stage a larger military offensive in Syria. This abandonment of the U.S.’s Kurdish allies at the behest of Turkey (which is a NATO ally but has been at odds with Washington) has provoked flak from Republican senators. However, it is well supported in U.S. public opinion (Chart 11). Trump is threatening to impose economic sanctions on Turkey if it engages in ethnic cleansing. The Turkish lira is the marginal loser, Trump’s approval rating is the marginal winner. The withdrawal sends a signal to the world that the U.S. is continuing to deleverage from the Middle East – a corollary with the return of focus on Asia Pacific. While the Iranians are key beneficiaries of this pivot, the Trump administration is maintaining maximum sanctions pressure on the Iranians. The firing of hawkish National Security Adviser John Bolton did not lead to a détente, as President Rouhani has too much to risk from negotiating with Trump. Instead the Iranians smelled U.S. weakness and went on the attack in Saudi Arabia, briefly shuttering 6 million barrels of oil per day. The response to the attack – from both Saudi Arabia and the U.S. – revealed an extreme aversion to military conflict and escalation. Instead the U.S. has tightened its sanctions regime – China is reportedly withdrawing from its interest in the South Pars natural gas project, a potentially serious blow to Iran, which had been hyping its strategic partnership with China. This reinforces the prospect for a U.S.-China ceasefire even as it redoubles the economic pressure on Iran. As long as the U.S. maintains the crippling sanctions on Iran, there is no guarantee that Tehran will not strike out again in an effort to weaken President Trump’s resolve. The fact that about 18% of global oil supply flows through the critical chokepoint of the Strait of Hormuz is Iran’s ace in the hole (Chart 12). It is the chief constraint on Trump’s foreign policy, as greater oil supply disruptions could shock the U.S. economy ahead of the election. Trump can benefit from minor or ephemeral disruptions but he is likely to get into trouble if a serious shock weakens the economy at this juncture. Chart 11U.S. Opinion Constrains Foreign Policy Chart 12Oil Price Constrains U.S. Policy Toward Iran An oil shock does not have to originate in Hormuz shipping or sneak attacks on regional oil infrastructure. Iran is uniquely capable of fomenting the anti-government protests that have erupted in southern Iraq. The restoration of stability in Iraq has resulted in around 2 million barrels of oil per day coming onto international markets (Chart 13). If this process is reversed through political instability or sabotage, it will rapidly push up against global spare oil capacity and exert an upward pressure on oil prices that would come at an awkward time for a global economy experiencing a manufacturing recession (Chart 14). Chart 13Iran's Leverage Over Iraq Chart 14Global Oil Spare Capacity Constrains Response To Crisis Bottom Line: Iran’s power over regional oil production is the biggest constraint on Trump’s foreign policy in the region, yet Trump is apparently tightening rather than easing the sanctions regime. The failure of the Abqaiq attack to generate a lasting impact on oil prices amid weak global demand suggests that Iran could feel emboldened. The U.S. preference to withdraw from Middle Eastern conflicts could also encourage Iran, while the tightening of the sanctions regime could make it desperate. An oil shock emanating from the conflict with Iran is still a significant risk to the global bull market. Brexit: The No-Deal Constraint The fifth and final constraint to discuss in this report pertains to the U.K. and Brexit. We do not consider the October 31 deadline a no-deal exit risk. Parliament will prevail over a prime minister who lacks a majority. Nevertheless the expected election can revive no-deal risk, especially if Boris Johnson is returned to power with a weak minority government. Chart 15U.K.: Public Opinion Constrains Parliament And No-Deal Brexit While parliament is the constraint on the prime minister, the public is the constraint on parliament. From this point of view, support for Brexit has weakened and the Conservative Party is less popular than in the lead up to the 2015 and 2017 general elections. The public is aware that no-deal exit is likely to cause significant economic pain and that is why a majority rejects no-deal, as opposed to a soft Brexit. Unless the Tory rally in opinion polling produces another coalition with the Northern Irish, albeit with Boris Johnson at the helm, these points make it likely that a no-deal Brexit will become untenable when all is said and done (Chart 15). If Johnson achieves a single party majority the EU will be more likely to grant concessions enabling him to get a withdrawal deal over the line. We remain long GBP-USD but will turn sellers at the $1.30 mark. Investment Implications The path of least resistance is for China’s stimulus efforts to increase – incrementally if trade tensions are contained, and sharply if not. This should help put a floor beneath growth, but the Q1 timing of this floor means that global risk assets face additional downside in the near term. We continue to recommend going long our “China Play” index. U.S.-China trade tensions should decline as President Trump looks to prevent higher unemployment ahead of his election. China has reason to follow through on small concessions to encourage Trump’s tactical trade retreat, but it does not face pressure to make new structural concessions. We expect a ceasefire – with some tariff rollback likely – but not a big bang agreement that removes all tariffs or deepens the overall bilateral economic engagement. Stay long our “China Play” index. We remain short CNY-USD on a strategic basis but recognize that a ceasefire presents a short term (maximum 12-month) risk to this view, so clients with a shorter-term horizon should close that trade. We are long European equities relative to Chinese equities as a result of the view that China will stimulate but that a trade ceasefire will leave lingering uncertainties over Chinese corporates. U.S. politics are highly unpredictable but constraint-based analysis indicates that while the House may impeach, the Senate will not remove. This, combined with Warren’s likely ascent to the head of the pack in the Democratic primary race, means that Trump remains favored to win reelection, albeit with low conviction (55% chance) due to a weak general approval rating and economic risks. The risk to U.S. equities is immediate, but should dissipate. The U.S. is rotating its strategic focus from the Middle East to Asia Pacific, which entails a continued rotation of geopolitical risk. However, recent developments reinforce our argument in July that Iranian geopolitical risk is frontloaded relative to the China risk. This is true as long as Trump maintains crippling sanctions. Iran may be emboldened by its successes so far and has various mechanisms – including Iraqi instability – by which it can threaten oil supply to pressure Trump. This is a tail risk, but it does support our position of being long EM energy producers. Matt Gertken, Vice President Geopolitical Strategist mattg@bcaresearch.com Footnotes 1 Please see BCA Research, China Investment Strategy Weekly Report, “Mild Deflation Means Timid Easing,” October 9, 2019, available at cis.bcaresearch.com. 2 China knows that Trump wants to seal a deal prior to November 2020 to aid his reelection campaign, while Trump needs to try to convince China that he does not care about election, the stock market, or anything other than structural concessions from China. Hence the U.S. blacklisted several artificial intelligence companies and sanctioned Chinese officials in advance of the talks. The U.S. opened a new front in the conflict by invoking China’s human rights abuses in Xinjiang, which is also an implicit warning not to create a humanitarian incident in Hong Kong where protests continue to rage. These are pressure tactics but have not yet derailed the attempt to seal a deal in Q4.
ハイライト
トランプ大統領が共和党内で支持され、決定的な証拠がないことは罷免を阻むだろう。
弾劾手続きでトランプ氏の支持率が恩恵を受け、米国経済が底堅ければ、貿易リスクは高まるだろう。
欧州本土の政治リスクは低下している。しかしロシアとトルコには注意が必要で、英国の10年物対2年物ギルトをショートせよ。
スペインの新選挙は政治的膠着を解消しない可能性がある。
香港ハンセンのショートで利益を確定する。
特集
米国のドナルド・トランプ大統領に対する弾劾手続き、露骨なイランによるサウジ攻撃、貿易戦争リスクの残存、そして中国と欧州からの追加の弱いデータは、投資家は当面リスク回避の姿勢を維持すべきであることを示唆している。具体的には、トランプ氏の弾劾は彼を国外での気晴らしに駆り立てる可能性があり、始まったばかりの積極的な対外・貿易政策からの戦術的撤退を放棄することになり得る。
ホットスポット以外の地政学リスクは低下しており、特に欧州で目立つ。ノーディール・ブレグジットのリスクは当社の予想に沿って急落した。イタリアとドイツは市場を安心させるためにポピュリズムなき財政刺激を提示し、市場を喜ばせた。フランスではエマニュエル・マクロン大統領の人気が回復している。そして本レポートで論じるように、スペインの選挙は重大な懸念材料を追加しないだろう。
以下では新しいGeoRisk指標を紹介し、過去1か月にわたる当社のすべての指標からのシグナルを概観し、その後スペインに焦点を当てる。
恐れるべきは米国政治であって弾劾自体ではない
下院民主党によるトランプ氏の弾劾決定は、投資家がリスク資産に対して慎重であり続けるもう一つの理由を与える。なぜ強気になれないのか？確かに、弾劾が決定的な証拠なしに行われれば、トランプ氏の再選確率は高まりうる。これは民主党の勝利に比べれば市場にとってプラスである。トランプ大統領は、共和党が引き続き91%の支持率で支える限り、事実上民主党の弾劾手続きに対して無敵である（チャート1）。このような状況では上院議員が離反することはなく、トランプ氏は職を追われることはないだろう。
共和党の支持が高い限り、トランプ氏は弾劾手続きに対して無敵である。
さらに、ウクライナ大統領ヴォロディミル・ゼレンスキーとの電話会話の議事録は決定的な一撃にはならなかった。トランプ大統領が軍事支援を差し止める代わりにジョー・バイデン前副大統領やその息子ハンターに関する捜査を要求するという明確な「見返り」は示されていない。従って不正行為があったかどうかは、さらなる証拠を待つまでは議論の余地がある。これは「内部告発者の申し立て」を超える証拠を含み得るもので、同申し立てはトランプ陣営が前述の電話議事録の情報を抑えようとした可能性を示唆している。重要なのは、草の根の共和党と上院がこの議論の最終的な裁定者であるという点である。
問題は、スキャンダルと弾劾が株式市場のボラティリティに供給されることが依然として考えられることである（チャート2）。下院民主党は弾劾に全面的に注力し、情報機関の内部告発者からの証言を聴取する過程で新たな証拠を掘り起こす可能性がある。
チャート1
共和党はまだトランプを弾劾する用意がない
弾劾、貿易戦争、そしてスペインへの短期滞在 – GeoRisk Update: 2019年9月27日
弾劾、貿易戦争、そしてスペインへの短期滞在 – GeoRisk Update: 2019年9月27日
弾劾はまた、民主党の大統領予備選を通じて市場にネガティブな影響を与える。エリザベス・ウォーレンはまだ初期の民主党予備選でバイデンを押しのけていない。
チャート2
弾劾手続きはボラティリティを高める可能性
弾劾手続きはボラティリティを高める可能性が高い
弾劾手続きはボラティリティを高める可能性が高い
もし彼女（ウォーレン）がバイデンを追い落とせば、市場には大きなネガティブ・インパクトが生じるだろう。トランプ大統領は依然として再選で僅かに有利であるに過ぎない。いかなる場合でもこの選挙は極めて接戦であり、財政政策と規制に対して重大な影響を持ち、従って2020年11月まで多くの不確実性を生むだろう。内部告発者を巡る一連の出来事は、この不確実性をむしろ悪化させている。
レポート冒頭でも述べたように、もし弾劾手続きが何らかの勢いを得れば、それはトランプ氏を国外での気晴らしに駆り立てる可能性があり、始まったばかりの積極的な対外・貿易政策からの戦術的撤退を放棄させることになり得る。
最後に、トランプ氏の再選は代替案より市場に優しいため安心ラリーを引き起こす可能性が高いが、一見したほど強気ではない。第2期のトランプ政策は第1期ほど企業に有利ではないだろう。選挙上の懸念から解放されつつも下院が民主党であるという状況では、減税は実現困難だが、対外・貿易政策をさらに攻撃的に進める可能性が高い。これは米国の長期的利益に資するか否かに関わらず、市場にとってプラスの見通しではない。
結論：トランプ大統領の共和党有権者間での支持率が重要な指標である。彼らが信頼を捨てない限り上院は反転せず、トランプ氏の支持はむしろ上がる可能性がある。しかしそれは強気転換の理由にはならない。今後1年は米国の政治的機能不全の恐怖劇が不可避であり、ボラティリティと潜在的に海外での紛争エスカレーションを引き起こすだろう。
発表…当社の米中貿易リスク指標
今週、米中貿易戦争のための新しいGeoRisk指標を導入する（チャート3）。この指標は、全体の先進国株式が中国エクスポージャーの高い銘柄群に対してどの程度アウトパフォームしているか、および中国の民間クレジット成長（「社会総融資」）に基づいている。チャートの説明が示すように、この指標は貿易戦争を通じた事象の推移と整合している。また、報道記事中の重要語のカウントなど別の貿易リスクの測度ともかなり相関している。
チャート3
ここから貿易リスクは上昇するだろう
弾劾、貿易戦争、そしてスペインへの短期滞在 — GeoRiskアップデート：2019年9月27日
弾劾、貿易戦争、そしてスペインへの短期滞在 — GeoRiskアップデート：2019年9月27日
執筆時点で当社の指標は貿易戦争関連のリスクが増加していることを示唆している。過去1か月、トランプ氏は選挙前の経済リスクを抑えるために対外・貿易政策で戦術的撤退を行ってきたが（経済リスク管理のため）、当社の指標はこれが既に織り込まれていることを示している。
問題は、トランプ再選のリスクが中国にとって一層厳しい交渉を可能にすることであり、これはFedExの従業員拘束（米企業を困らせ得るシグナル）やモンタナ、ネブラスカでの農場視察のキャンセルにより暫定的に確認されている。これらは大事件ではないが、中国がトランプの躊躇を嗅ぎ取り、交渉で攻勢に出ていることを示唆している。
主要交渉担当者は10月上旬に極めて重要な協議ラウンドで会合する予定である。これが実質的な進展の公表や、4月にほぼ完成しているドラフト文書が仕上がることを示せば、11月のAPECサミット（チリ・サンティアゴ）で習近平国家主席とドナルド・トランプ大統領の首脳会談が設定される可能性がある。この時点で、我々は2020年11月までに合意が成立する確率を上方修正する必要があるだろう（当社は40%と見積もっている）。
もし協議が前向きな公的成果で終わらなければ、投資家はそれを軽視すべきではない。第4四半期の交渉は米国選挙前の最後の合意の試みである可能性があり、トランプ＝習の首脳会談の話がない場合、我々のエンドゲームに対する悲観的見通しが裏付けられることになる。
米中貿易協議が決定的で持続的な合意を生む可能性は低い。
最終的に我々は、米中貿易協議が貿易戦争リスクと不確実性を実質的に取り除くような決定的かつ持続的な合意を生むとは考えていない。特に世界的な金融緩和の中で金融市場・経済圧力が十分に強くなく、政策決定者を妥協に駆り立てない場合にはその可能性は低い。しかし、弾劾手続きがトランプの戦術的撤退を持続させ、中国からの相互措置を引き出している兆候があれば、見通しはより楽観的になるだろう。
結論：大統領の支持率が民主党の弾劾手続きから恩恵を受け、かつ我々が予想するように米国経済が底堅ければ、トランプ氏は中国との浅い合意に屈することを回避できる。ここから貿易リスクは上昇し得る。
同様に、弾劾手続きは最終的にトランプ氏に再び戦術を変えさせ、対外政策でより攻撃的な姿勢を取らせる可能性がある。弾劾に勢いがつくか、ベアマーケットが発生すれば、彼は大統領就任以降で最も攻撃的になることがあり得る—その攻撃は中国（あるいはイラン、北朝鮮、ベネズエラ、その他の国）に向けられるかもしれない。
我々の見方に対するリスクは、中国が自国経済の猶予を得るためにトランプの貿易姿勢を受け入れ、両者がAPECサミットで合意に達することである。
欧州のリスクは低下、ロシアとトルコのリスクはこれ以上ほとんど下がらない
その他の地域では、当社の地政学リスクの測定は多数の先進国および新興国で緊張の低下を示している（付録参照）。ドイツではリスクは現状からやや上昇し得るが概ね抑制されている—これは短期を除けば英国では当てはまらない。ロシアとトルコでは、これ以上リスクが下がる余地はほとんどない。
まずドイツだが、メルケル首相の与党連立が気候変動対策として500億ユーロの財政支出パッケージで合意したことで政治リスクは低下した。この合意は、ドイツ政治が基本的に安定している一方で、行政は刺激策を先取りして打つというよりは反応的に行動するだろうという当社の評価を裏付けるものだ。
欧州がドイツの財政政策における真の「ゲームチェンジャー」を待つには、世界的な危機、あるいは新たなドイツ政府が必要だろう。世論調査で急伸している緑の党が、メルケルを気候支出へ駆り立てたため、そのような展開を可能にするかもしれないが、まだ早すぎる。
一方で、メルケルの退任間際の状態と外部要因が政治リスクを完全には収束させないだろう。我々は、米国車の関税が現状より高まる確率を30%以下と見ている—少なくとも米中の緊張が続く限りは。
対照的に、英国の政治リスクは今月大きく改善したにもかかわらず、抑制されているとは言えない。9月25日の最高裁判所による首相ボリス・ジョンソンの議会休会（プログ）無効判決は、合意なきEU離脱で国を引き裂くという彼の脅しの棺にもう一打を加えた。これはEUから譲歩を引き出すための賭けだったが、完全に失敗した。1 これが、最も説得力のあるノーディール離脱の脅威であったため、その失敗は英国と近隣国の政治リスク低下の一歩を意味するはずだ。
しかし逆説的に、我々のGeoRisk指標は夏を通じておよび現在のポンドの急落を裏付けられなかった。理由は、夏の間ポンドの減価率は比較的横ばいであった一方、当該指標の説明変数の一つである英国製造業PMIは世界的な製造業の急落に伴いもっと速く低下したためである。その結果、当社の指標は政治リスクの低下としてこれを記録した。世界はノーディールよりも景気後退を恐れており、市場の判断は正しかった。しかし状況は逆転し得る：世界成長が改善し、新たな英国選挙が予定されれば、後者はノーディールのリスクを再燃させる可能性がある（特にトーリー党が薄い過半数で連立政権として戻った場合はなおさらだ）。
真実は、ブレグジットの物語は終わっておらず、英国は選挙、左派政権の可能性、そして最終的には離脱も残留も中間層の不安を解決しないことが明らかになればポピュリズムの粘り強さに直面するだろう。我々のGBP-USDのロング推奨は必然的にタクティカルであり、1.30ドルで売りに転じる予定である。
新興市場では、ロシアとトルコの政治リスクは非常に低下しており、何らかの政治展開が起こらない限りこれ以上低下するのは難しい。最新の評価に基づけば、トルコは近い将来リスクが急上昇する可能性が高い。これはエルドアン大統領に対する国内政治的連携の形成や、脆弱な米国とトルコのシリア協定を巡る外的リスクの高まりによって生じ得る。イランとの緊張はオイルショックを引き起こし、経済を弱体化させ野党を勢いづける可能性もある。
ロシアについては、我々のベースケースはロシアが対外目的を軽視して国内問題に注力し続けることであり、これが地政学リスクを低位に保つのに寄与するというものだ。米国の政治が混乱し、対イランの紛争が視野に入る中で、モスクワが自ら敵対的注目を浴びる理由はない。しかしながら、プーチン時代を通じてモスクワは予測不可能で攻撃的であり、トランプに対する忠誠心は本物ではなく民主党の怒りの標的となり得るし、中東やアジア太平洋で火種を煽る誘因も持つ。したがって地政学リスクがこれ以上大幅に下がることを期待するのは運を天に任せることになる。
結論： 欧州の政治リスクは低下している が、メルケルの退任間際の状態と貿易戦争により、政権基盤が安定しているにもかかわらずドイツのリスクはここから上昇し得る。
英国は今夏のノーディール・リスクの回避という幸運な結論にもかかわらず、世代的に高まった政治リスクに直面している。英国の10年物対2年物ギルトをショートしなさい。
ロシアは当面静かであり続けるべきだが、トルコはほぼ確実に政治リスクの上昇を経験するだろう。
スペイン：選挙は驚きをもたらすかもしれないがリスクは低い
政党幹部が恒久的な政府樹立で合意できなかったため、スペインの有権者は11月10日に4年で4度目の投票に向かうことになる。
スペイン社会労働党（PSOE）は4月の解散総選挙で350議席中123議席を獲得して以降、暫定政権を務めている。
新たなスペインの選挙は現在の政治的膠着を解消しないだろう。
首相でありPSOE党首のペドロ・サンチェスは7月に承認を得られず、それ以来左派の反体制政党ポデモスと政権協定を模索してきた。ただしPSOEは完全な連立を求めているわけではなく、単に少数与党として引き続き統治するための外部支持を求めているに過ぎない。したがって交渉でPSOEはポデモスに閣僚ポストではなく非閣僚の機関を提供する程度にとどめ、ポデモスや他党は選挙の準備を整えている。
今後の選挙の結果は4月の選挙と大きくは変わらないかもしれない。スペインの有権者は変化を求めていない。失業と不完全雇用は減少しており、賃金上昇は2014年以降プラスで推移している（チャート4）。世論調査では各党への支持は大きく変動していない（チャート5、上段）。PSOEは依然としてかなりの差でリードしている。
チャート4
スペイン有権者は変化を求めていない
スペインの有権者は変化を求めていない
スペインの有権者は変化を求めていない
とはいえ選挙は不都合な時期に不確実性を高め、驚きを生む可能性がある。PSOEの支持は7月下旬以降わずかに低下しており、これはポデモスとの交渉がこじれ始めた時期に一致する。
チャート5
世論調査に大きな変化はない…
世論調査に大きな変化なし...
世論調査に大きな変化なし...
たとえPSOEとポデモスが統治協定を結んだとしても、両者の合計支持は主要な保守系3党の合計支持を大きく上回るわけではない。保守系は国民党（Partido Popular）、シウダダノス（Ciudadanos）、Voxであり（チャート5下段）、彼らはマドリードの地域政府を共同で支配することで協力できることを最近示した。
チャート6
…しかし投票率低下は左派に打撃を与える可能性
弾劾、貿易戦争、そしてスペインへの滞在 – GeoRiskアップデート：2019年9月27日
弾劾、貿易戦争、そしてスペインへの滞在 – GeoRiskアップデート：2019年9月27日
社会党はシウダダノスから際どい有権者を取り込むことを望んでおり、特にシウダダノスの右派ポピュリズムへの転向やカタルーニャ問題に対する強硬姿勢に懐疑的な有権者を狙っている。しかしシウダダノスの有権者の半分を取り込めたとしても、PSOEの支持は約37%にとどまり、単独過半数政権を形成するには程遠い。
PSOEに打撃を与え得るもう一つの要素は投票率である。スペインの有権者は4月選挙以降、いずれの党も支持することへの関心が薄れている。投票率の低下は左派にとって最も打撃になり得る。なぜなら有権者は政府形成失敗をポデモスとPSOEの責任と見なす割合が、PPやシウダダノスよりも高いからである（チャート6）。
最も可能性の高い結果は現状維持か、あるいはPSOE–ポデモス連合だ。しかし保守派の勝利を排除することはできない。前者2ケースでは短期的にはやや拡張的な財政が実施されやすくなるが、長期的には改革の勢いを失うリスクがある。
文脈を示すと、スペインの政治は国内志向であり、欧州統合への脅威とはなっていない。スペインの有権者は通貨やEU加盟に関して大陸で最も親欧的な層の一つである（チャート7）。スペインはイタリアとともにEU予算配分の主要な受益国である。極右のVoxですら「強硬なユーロ懐疑主義者」と見なされてはいない。
ただし国内に目を向けると政治的分断が問題である。不平等や社会的流動性の欠如はイタリア、英国、米国ほど極端ではないにせよ懸念材料だ。さらにカタルーニャ独立問題は対立を生む。新たなカタルーニャ州議会選は2022年まで予定されていないが、共和主義左派（Republican Left of Catalonia）とカタルーニャ・シーの親独立連合は世論調査で勢いを増しており、シウダダノスの支持は今年初めに同党がカタルーニャに対する姿勢を強硬化して以来急落している（チャート8）。カタルーニャが独立するという状況では全くない—独立支持は2013年にピークに達している—が、それでもスペイン政治の原動力であり続けている。
チャート7
スペイン人は欧州を好む
スペイン人はヨーロッパを愛している
スペイン人はヨーロッパを愛している
チャート8
カタルーニャは分裂を招く問題
弾劾、貿易戦争、そしてスペインへの滞在 — GeoRiskアップデート：2019年9月27日
弾劾、貿易戦争、そしてスペインへの滞在 — GeoRiskアップデート：2019年9月27日
ごく短期的には、選挙の麻痺は財政政策にクロスウインドを生む。一方では地方政府は支出削減を強いられる可能性がある。地域は昨年より50億ユーロ多く受け取ると期待しており、その一部は医療や教育に使われる予定だった。安定（あるいは少なくとも暫定）政権が2019年予算を承認できるまでは、地域は2019年予算を昨年の数値に基づいて作成するため、予定されていた支出増加を削らざるを得ない。
しかし他方で、税収が回収できないため予算赤字は拡大するだろう。2018年末にスペインは年金、公務員給与、最低賃金の引き上げを法令で実施したが、2019年予算で実施されるはずだった対応する歳入増加は政権が確立するまで実現しないため、赤字は上方圧力を受ける。
選挙を越えれば、大陸の景気減速を受けてやや大きめの財政的押し上げが期待される。スペインには多少の財政余力があり、2019年に財政赤字は2%、2020年に1.1%へ低下すると見込まれている。2 欧州委員会のより保守的な見積もりでも2019年と2020年の赤字はそれぞれ2.3%と2%と予想されている（チャート9）。これは、スペインが過去10年の緊縮の後に歓迎される変化として、2020年に過度の赤字手続きを起動させることなく追加で約100～150億ユーロ分の刺激を提供できることを意味する。
リスクは、スペインの構造改革の勢いが失われ、長期的に悪影響を及ぼす可能性があることだ。2012年、スペインは痛みを伴う労働市場と年金改革を実行し、それが印象的な経済回復を支えた。我々の報告が示す通り、経済は同業国平均より速く成長し続け、失業は過去6年で12%低下し、輸出競争力は2008年以降ヨーロッパで最も急速に回復した国の一つである（チャート10）。この回復は現在減速し始めており、現時点の政治的膠着は改革が市場の望むより深く巻き戻されるリスクを生んでいる。
チャート9
スペインにはある程度の財政余地がある
スペインにはいくらかの財政余地がある
スペインにはいくらかの財政余地がある
保守派が政権に戻るという驚きが起これば、これは回避される可能性が高いが、その場合は短期的に緩和的な政策は少なくなるだろう。
チャート10
回復は減速し始めている
回復が鈍化し始めている
回復が鈍化し始めている
結論：当社の地政学リスク指標はスペインに関して抑制されたリスク水準を示している。これは、選挙が大きな変化をもたらさない可能性があり、いずれにせよ同国は不安定な均衡状態にとどまるだろうという点に適合している。政治は米国、英国、イタリアのようなポピュリズムに侵された国々よりも基本的に安定している。しかし、左派政権が生じれば短期的にはより大きな財政的緩和が行われ、その代償としてスペインが最近達成した構造改革の進展が損なわれるというリスクがある。
事務連絡
香港ハンセンのショートで利益を確定している。混乱はまだ終わっていないが、10月1日の中華人民共和国建国記念日が近づくにつれてピークに達し、北京は強硬な介入を避けようとするだろう。
エカテリーナ・シュトレヴェンスキー、リサーチ・アナリスト ekaterinas@bcaresearch.com
マット・ガートケン、副社長 地政学ストラテジスト mattg@bcaresearch.com
脚注
1 最高裁はジョンソン政権による議会休会が、正当な理由なく議会の主権的立法者としての役割および政府監視の役割を不当に骨抜きにする違法な手段であると判断した。通常より大規模な11人の裁判官が全会一致で休会の無効を判決した。歴史的に見て休会の使用例や、議会が10月31日のブレグジット日までに行動する時間がまだあったこと、そして首相の対外関係や条約に関する歴史的権限を考えれば、我々は少なくとも判決は接戦になると予想していた。しかし最高裁はブレグジットの混乱の中で議会の麻痺によって生じた権力の真空を埋める役割を果たし、首相が重要な局面で議会の役割を縮小できるという新たな前例になり得るものを「打ち砕いた」。実務的な短期的帰結はノーディール退出の政治的・経済的リスクの低下であるが、長期的帰結は英国の絶えず進化する憲法制度における司法の重要性の高まりかもしれない。
2 「Stability Programme Update 2019-2022, Kingdom of Spain」を参照、入手先は www.ec.europa.eu。
英国：GeoRisk指標
英国：GEORISK 指標
英国：GEORISK 指標
フランス：GeoRisk指標
フランス：GEORISK指標
フランス：GEORISK指標
ドイツ：GeoRisk指標
ドイツ：GEORISK指標
ドイツ：GEORISK指標
スペイン：GeoRisk指標
スペイン：GEORISK指標
スペイン：GEORISK指標
イタリア：GeoRisk指標
イタリア：ジオリスク・インジケーター
イタリア：ジオリスク・インジケーター
ロシア：GeoRisk指標
ロシア：ジオリスク・インディケーター
ロシア：ジオリスク・インディケーター
トルコ：GeoRisk指標
トルコ：GEORISKインジケーター
トルコ：GEORISKインジケーター
ブラジル：GeoRisk指標
ブラジル：ジオリスク・インディケーター
ブラジル：ジオリスク・インディケーター
台湾：GeoRisk指標
台湾：GEORISK指標
台湾：GEORISK指標
韓国：GeoRisk指標
韓国：GEORISKインジケーター
韓国：GEORISKインジケーター
地政学的レーダー上の注目点は？
弾劾、貿易戦争、そしてスペインへの短期滞在 — GeoRisk アップデート：2019年9月27日
弾劾、貿易戦争、そしてスペインへの短期滞在 — GeoRisk アップデート：2019年9月27日
第III部：地政学カレンダー
Highlights Four ghosts of 2016 are knocking at the door: Brexit, Trump, Brazil, Italy. President Trump and U.S. trade policy are keeping uncertainty high. Upgrade the odds of a no-deal Brexit to about 33%. Expect limited stimulus from Italy and Germany – for now. Brazil’s pension reform is entering its final stretch – buy the rumor, sell the news. Feature Four major political events of 2016 are returning to affect the global investment landscape this fall – though only two of these ghosts are truly frightening. In order of market relevance: Trump: The election of Donald J. Trump as U.S. president, November 8, 2016 Brexit: The U.K. referendum to leave the European Union, June 23, 2016 Italy: The Italian constitutional referendum, December 4, 2016 Brazil: The removal of Brazilian President Dilma Rousseff, August 31, 2016 Italy and Brazil are producing market-positive political results in the short run. Brexit and Trump pose substantial and immediate risks to the global bull market. A pivot by Trump is the headline risk to our view that no trade agreement will be concluded by November 2020, as we outlined in a Special Report last week. At the moment tensions are still escalating. President Trump has ordered an increase in tariffs (Chart 1) and threatened to invoke the International Economic Emergency Powers Act of 1977, which would give him the ability to halt transactions, freeze funds, and appropriate assets. China is retaliating proportionately and virtually incapable of softening its tone prior to its National Day celebration on October 1. The next round of negotiations, slated for Washington in September, could be a flop like the talks in July, or it could be canceled. Investors should stay defensive. The equity market will have to fall to force Trump to stage a tactical retreat. Meanwhile China could intervene violently in Hong Kong SAR. That possibility, the nationalist military parade on October 1, and U.S. actions toward the South China Sea and Taiwan, show that sabers are rattling, causing additional market jitters. Chart 1Trump's Latest Tariff Salvo U.S.-China tensions underpin our tactical safe-haven trade recommendations. But we are not shifting to a cyclically bearish stance until we get clarity on Trump’s and Xi’s handling of their immediate predicament. Brexit is the other acute short-term risk. This was true even before Prime Minister Boris Johnson opted to prorogue parliament from September 10 to October 14, shortening the time that parliament has to either pass a law forbidding a no-deal exit or bring down Johnson’s government in a vote of no confidence. We are upgrading the odds of “no deal” to no higher than 33%, using a conservative decision-making process (Diagram 1). No-deal is not our base case because parliament, the public, and even Johnson himself want to avoid a recession, which is the likely outcome, even granting that the Bank of England will not stand idly by. We are upgrading the odds of “no deal” Brexit to about 33%. Diagram 1Brexit Decision Tree (Revised August 29, 2019) From a bird’s eye point of view, the pound is very attractive (Chart 2). But in the near-term the twists and turns of Britain’s political struggle imply that we will see wild volatility. Our foreign exchange strategists expect that a no-deal Brexit would cause GBP/USD to collapse to 1 after October 31. Assuming our one-in-three odds of such an outcome, the probability-weighted average of cable is about 1.2. Hence investors should not short sterling from here, unless they strongly believe we are underrating the odds of no-deal exit. In the worst-case scenario, a no-deal Brexit will cause an economic shock at a time when Europe is on the brink of recession – Italy and Germany are virtually there. This means there is a substantial risk of additional deflationary pressure piling onto German bunds and sustaining the global bond rally. This pressure will be sharply reduced if Johnson loses an early no confidence vote, but that is a 50/50 call so we would not call time on this rally yet. Stay cautious. Chart 2Pound Can Only Go So Low Italy: Stimulus … Without A Bruising Brussels Battle Italy has avoided a new election by producing an unusual tie-up between the establishment Democratic Party and the anti-establishment Five Star Movement (M5S). The coalition still needs to clear some internal hurdles and an online vote by Five Star members, but an agreement is to be presented to President Sergio Mattarella as we go to press. This is the most market-friendly outcome that could have been expected, as is clear through the sharp drop in Italian government bond yields (Chart 3). Our GeoRisk indicator for Italy is also collapsing. Chart 3Markets Cheer New Italian Coalition This development marks the climax of a story line that we outlined in 2016, when Prime Minister Matteo Renzi lost a constitutional referendum that aimed to strengthen Italian governments to enable deeper structural reforms (he subsequently resigned). At that time we argued that Italy would emerge as a market-relevant political risk due to rampant anti-establishment sentiment, but that this risk would subside when Italy’s populists were shown to be pragmatic at heart, i.e. unwilling to push their conflicts with Brussels to a point that truly reignited European break-up risk. This view is now vindicated – and not only for the short-term. The new coalition comes at the nick of time, with Europe teetering on recession and the risk of a no-deal Brexit rising. The new government will have to deliver the 2020 budget to the European Commission by October 15. The budget will aim to provide fiscal support, including a delay of the legislatively mandated hike in the Value Added Tax from 22% to 24.2%, already rolled over from 2019. The Five Star Movement will demand as a price for its participation in the coalition that social spending go up; the Democratic Party will have learned a lesson while out of power and will be more fiscally permissive and strike a tougher tone with Brussels. The Italian budget talks will be a non-issue: the coalition will cooperate with Brussels. The episode demonstrates that the Italian risk to financial markets is overrated. This point goes beyond the fact that the Democrats and Five Star were able to cooperate. Italy’s leading populist parties have already shown that they are pragmatic and will play the game with Brussels to avoid a financial breakdown. In May 2018, the newly formed populist coalition proposed a gigantic “wish list” budget that would have increased the budget deficit to roughly 7.3% of GDP in 2019. They also appointed a euroskeptic economy minister who almost prevented government formation. The ensuing conflict with Brussels triggered considerable turmoil (Chart 4). Ultimately, however, the populists did precisely what we expected: they bowed to the severe financial constraint on Italy’s banking system. They agreed to a 2019 and 2020 deficit of 2.04% and 2.1%, respectively (Chart 5). Chart 4Italian Populists Prove Pragmatic Chart 5Even Salvini Compromised On Budget Clash At present, the market is relieved that an election was avoided that might have seen Salvini and the League form a government with a much smaller right-wing party (Fratelli D’Italia) (Chart 6) – but the truth is that Salvini had already capitulated to the EU, both on budget matters and the euro currency. He was hardly likely to push for a budget more aggressive than that of the initial proposal in 2018. The clash with Brussels would have been a flash in the pan; the result would have been greater fiscal thrust, which would have been market-positive in the current environment. Chart 6Election Would Have Meant More Stimulus ... And More Political Risk M5S will also push for more spending and has also moderated their stance on the euro. A coalition with the Democrats will not work if the purpose is to push a euroskeptic agenda. There will be a focus on counter-cyclical fiscal policy, pragmatic reforms that the two can agree on, and fighting corruption. The budget talks will be a non-issue: the Democratic Party is an establishment party and the coalition will cooperate with Brussels. Furthermore, the context has changed since 2018 in a way that will reduce budget frictions. There is a need for countercyclical fiscal policy in light of the global slowdown, so the European Commission will have to be more flexible on the budget. This is particularly true if Germany itself loosens its belt on a cyclical basis. The risk to the above is that the coalition shaping up between the Democrats and Five Star is an alliance of convenience that will break down over time. Five Star will remain hard-line on immigration, which is driving anti-establishment sentiment. Italian elections are a frequent affair. Salvini and the League will be waiting in the wings, especially if Brussels proves too tight-fisted or if the Democrats do not toughen their stance on immigration. But as outlined above, Salvini’s own evolution on the euro, on northern Italy, and on the budget and financial stability shows that the economy will have to get a lot worse before Italian euroskepticism presents a renewed systemic risk. Bottom Line: The tentative coalition taking shape in Italy will produce a modest increase in fiscal thrust with minimal frictions with Brussels. As such it is the most market-friendly outcome that could have occurred from Salvini’s push to seize power. Beneath this episode of government change is the political arrangement taking shape in Italy, and across Europe, which calls for a commitment to the European project and currency. The price of this commitment is a tougher line on immigration from European leaders. Germany: Fiscal Loosening, But Not For The States (Yet) Our GeoRisk indicator for Germany is pointing to an increase in risk in recent weeks. Germany is threatened by a potential technical recession and while fiscal stimulus is in preparation, there will not be a fiscal game-changer until Merkel steps down in 2021 – barring a total collapse in the economy that forces her hand in the meantime. The outlook is not improving (Chart 7, top panel). The economy shrank by 0.1% in Q2 2019, exports are falling, and passenger car production is at the lowest level ever recorded (Chart 7, bottom panels). Chart 7German Economy Gets Pummeled Chart 8Germany: Expect Orthodox Stimulus For Now Finance Minister Olaf Scholz has announced that Germany could increase government spending by $55 billion within the context of European and German budget constraints. Split proportionally between 2019 and 2020, this additional spending would not put Germany in violation of the “black zero” rule – a commitment to a balanced budget that limits the federal structural deficit to 0.35% of GDP – even without any additional revenue (Chart 8). There will not be a fiscal game-changer in Germany until Merkel steps down – barring a crisis. The German Chancellery reports that it does not see the need for stimulus in the short term – as long as trade tensions do not escalate and there is no hard Brexit. At present, however, trade tensions are escalating and the odds of a no-deal Brexit are increasing. Moreover China’s economy and stimulus efforts continue to disappoint. In this context Germany’s ruling coalition is putting together a climate change package that would entail additional spending (while stealing some thunder from the increasingly popular Green Party). Given the European Commission’s forecast of Germany’s 2020 budget surplus, 0.8% of GDP, the government could ultimately go further than Scholz’s ~$50bn. This is because the black zero rule provides for exceptions in case of recession (or natural disasters or other crises out of governmental control) with a majority vote in the Bundestag. Hence we are not so much concerned about the magnitude of the stimulus as its timing. First, Merkel and her coalition typically move slower than the market would like in the face of financial and economic challenges. Second, according to the black zero rule, which is transcribed in the German constitution (the Basic Law), the Länder cannot run budget deficits from 2020. Amending the constitution to delay this deadline requires a two-thirds majority in the Bundestag and the Bundesrat – a much taller order than the simple majority needed to boost federal deficits. The governing coalition currently holds 56% of the seats in the Bundestag. If the Greens were brought on board, which they would be inclined to do, this number falls just short of two-thirds at 65.6%. In order to obtain a two-thirds majority in the Bundesrat, the Social Democrats, Christian Democrats, and the Greens would need the support of another party, either the Left or the Free Democrats. This could be done but it would require political will, which is only likely to be sufficient if the German and global economy get worse from here. Meanwhile financial markets will have to settle for the gradual implementation of a stimulus package on the order of 1% of GDP – the one the government is planning. Bottom Line: While Germany will likely roll out a stimulus package by Q4, if third quarter GDP data confirm that the country is in a technical recession, Merkel’s hesitation and budget limits mean that this stimulus will likely be moderate. A marginal upside surprise is possible but it will not represent a true “game changer” on fiscal policy in Germany. The game changer is more likely after Merkel steps down in 2021. The Green Party is surging in Germany and could possibly lead the next government. Even if it doesn’t, its success and Europe-wide developments are pushing German leaders to become more accommodative. Brazil: Reform Or Bust Political turmoil in Brazil over the past five years has ultimately resulted in a right-wing populist government under President Jair Bolsonaro. Bolsonaro is pursuing a pension reform that is universally acknowledged as necessary to straighten out Brazil’s fiscal books, but that the previous government tried and failed to pass. On this front the news is market-positive: having cleared the lower Chamber of Deputies, the pension reforms are now likely to pass the senate. This will lift investor confidence and give Bolsonaro an initial success that he may then be able to translate into additional economic reforms. The Brazilian economy and financial markets are moving in opposite directions. The currency and equities staged a mid-year rally despite negative data releases – shrinking retail sales and industrial production amid high unemployment (Chart 9). More recently these assets relapsed despite tentative signs of improvement on the economic front (Chart 10). All the while, chaos and controversies surrounding Bolsonaro’s government have weighed on his approval rating, ending the honeymoon period after election (Chart 11). Chart 9Brazil: Signs Of Improvement Chart 10Brazil: Markets Sold Despite Pension Progress Chart 11Bolsonaro’s Honeymoon Is Long Gone The mid-year equity re-rating was driven by an improvement in sentiment on the back of the government’s pension reform. The relapse occurred despite the passage of the pension reform bill in the lower house, indicating that global economic pessimism has dominated. The bill’s next step goes to the senate where it faces two rounds of voting before enactment (Diagram 2). It should clear this hurdle by a large margin, though we expect delays. Diagram 2Brazil: Pension Reform Timeline In the second round vote in the lower house on August 6 – which had a smaller margin of victory than the first round – deputies voted largely in line with party alliances (Charts 12A & 12B). Assuming legislators in the senate behave in the same way, the reform should gain the support of 64 of the 81 senators – easily surpassing the 49 votes needed. Even in a more pessimistic scenario where all opposition parties and all independent parties vote against the bill – along with two defecting senators from government-allied parties – the reform would pass by 56-25. Chart 12APension Bill Sailed Through Lower House ... Chart 12B... And Should Pass Senate In Time This favorable outlook is also supported by popular opinion, which indicates that the majority of those polled agree that pension reforms are necessary (Chart 13). This leaves two questions: How soon will the bill clear the senate? According to senate party leaders’ proposed timetable, the bill will undergo its first upper house vote on September 18 with the second round slated for October 2. This is ambitious. The strategy of Senator Tasso Jereissati – who has been appointed senate pension reform rapporteur – is to approve the text in its current form and create a parallel proposed amendment to the constitution (PEC) which will bring together the amendments that senators make to the original text. Dozens of amendments have been filed with the Commission on Constitution and Justice. These will prolong the enactment of the final bill and dilute its impact. We doubt the senate will let Jereissati have his way entirely and hence expect delays and dilution. Chart 13Brazil: Public Now Favors Pension Reform Chart 14Brazil: Pension Reform Not Enough How much savings will the bill generate? Will the reforms be sufficient to improve public debt dynamics in Brazil? The Independent Fiscal Institute of the senate estimates that the reform will generate BRL 744 billion of savings. This is significantly less than the BRL 1.2 trillion initially proposed, and lower than the BRL 860 billion that Economy Minister Paulo Guedes has indicated as the minimum fiscal savings required. Our Emerging Markets strategists argue that the bill falls short of what is needed. While the plan will reduce the fiscal deficit and slow debt accumulation, it will be insufficient to generate primary surpluses over the coming years (Chart 14).1 Moreover, estimated savings in the final bill will likely be further revised down as the bill undergoes more amendments in the senate. What comes after pension reform? The market has focused almost exclusively on this issue to the neglect of Bolsonaro’s wider economic reform agenda. The agenda includes privatization, trade liberalization, tax reforms, and deregulation. Here we are more skeptical. First, Bolsonaro will have spent a lot of political capital on pensions. Second, while the economy and unemployment are always important, they are not the foremost concern for Brazilians (Chart 15). Chart 15Bolsonaro Will Lose Political Capital After Pension Bill Third, the economic agenda is often at odds with Bolsonaro’s social, foreign, and environmental policies: The new Mercosur-European Union trade agreement and ongoing trade negotiations between Mercosur and Canada are positive developments. However the G7 summit in France highlighted that the deal with the EU is at risk due to dissatisfaction with Bolsonaro’s response to the Amazon fires. France and Ireland have threatened to withhold support of the ratification. With world leaders concerned about the political risks of trade liberalization, and with Trump having issued a license to foreign leaders for trade weaponization, an escalation of tensions between the Europeans and Bolsonaro could lead to punitive measures even beyond the delay to the Mercosur-EU deal. Brazil’s China problem: Bolsonaro has been cozying up to President Donald Trump while striking a more aggressive tone with China. This is a risky strategy as it may undermine Brazil’s economic interests. The country’s exports are much more leveraged to China than to the U.S. and have been benefitting on the back of the trade war as China substitutes away from the U.S. (Chart 16). The president’s planned trip to China in October reveals an attempt to mend ties after having accused China of dominating key Brazilian sectors during his election campaign. But it is not clear yet that Bolsonaro will stage a retreat. And if President Trump backtracks on his trade war in order to clinch a deal, Bolsonaro may have lost some goodwill with China without receiving the benefit of China’s substitution effects. Hence Bolsonaro will have to soften his approach to China to make progress on the trade aspect of the reform agenda. Chart 16Brazil: Time To Mend Ties With China Bottom Line: We expect the passage of a diluted pension reform bill that will slow the growth of public debt to some extent. However global headwinds are persisting. And any success on pensions should not be extrapolated to other items on the economic reform agenda. Bolsonaro’s trade liberalization faces difficulties on the surface. Other domestic reforms are even more difficult to achieve in the wake of painful pension cuts. Reforms that enjoy public support and do not require a complicated legislative process are the most likely to be implemented, but even then, legislation and implementation are likely to be long-in-coming in Brazil’s highly fractured congress. As a result we share the view with our Emerging Markets Strategy that the pension reform is a “buy the rumor, sell the news” phenomenon. Housekeeping We are booking gains on our long BCA global defense basket for a 17% gain since inception in October 2018. The underlying thesis for this trade remains strong and we will reinstitute it at an appropriate time, though likely on a relative basis to minimize headwinds to cyclical sectors. We are also finally throwing in the towel on our long rare earth / strategic metals equity trade. The logic behind the trade is intact but it was very poorly timed and the basket has depreciated 24% since inception. Matt Gertken, Vice President Geopolitical Strategist mattg@bcaresearch.com Roukaya Ibrahim, Editor/Strategist Geopolitical Strategy RoukayaI@bcaresearch.com Ekaterina Shtrevensky, Research Analyst ekaterinas@bcaresearch.com Footnotes 1 Please see BCA Research’s Emerging Markets Strategy Weekly Report “On Chinese Banks And Brazil,” dated July 18, 2019, available at ems.bcaresearch.com. France: GeoRisk Indicator U.K.: GeoRisk Indicator Germany: GeoRisk Indicator Italy: GeoRisk Indicator Spain: GeoRisk Indicator Russia: GeoRisk Indicator Korea: GeoRisk Indicator Taiwan: GeoRisk Indicator Turkey: GeoRisk Indicator Brazil: GeoRisk Indicator What's On The Geopolitical Radar? Geopolitical Calendar
Highlights So What? Prime Minister Boris Johnson’s threat to take the U.K. out of the EU without a withdrawal deal in place is a substantial 21% risk. Why? The odds of a no-deal exit could range from today’s 21% to around 30%, depending on whether Johnson manages to obtain some concessions from the EU in forthcoming negotiations. It is far too early to go bottom-feeding for the pound sterling, as Brexit risks are asymmetrical. We maintain our tactically cautious positioning, despite some cyclical improvements, due to elevated geopolitical risks in the United States, East Asia, and the Middle East. Feature Thank you Mr. Speaker, and of course I should welcome the prime minister to his place … the last prime minister of the United Kingdom. – Ian Blackford, head of the Scottish National Party in Westminster, July 25, 2019 Chart 1No-Deal Brexit Would Come At A Very Bad Time The Federal Reserve cut interest rates for the first time since the global financial crisis in 2008 on July 31. The Fed suggested that the door is open for future cuts, though Chairman Jerome Powell signaled that the cut should not be seen as the launch of a “lengthy rate cutting cycle” but rather as a “mid-cycle adjustment” comparable to cuts in 1995 and 1998. President Donald Trump responded by declaring a new 10% tariff on $300 billion worth of imports from China! He resumed criticizing Powell for insufficient dovishness – and Trump could in fact fire Powell, though the decision would be contested at the Supreme Court. The Fed’s move shows that Trump’s direct handle on interest rates comes from his ability to control trade policy and hence affect the “the external sector.” The trade war with China has exacerbated a global manufacturing slowdown that is keeping global growth and U.S. inflation weak enough to justify additional rate cuts with each future deterioration (Chart 1). Improvements in global monetary and fiscal policy suggest that the U.S. and global economic expansion will be extended to 2021 or beyond, which is positive for equities relative to government bonds or cash, but we remain defensively positioned in the near-term due to a range of geopolitical risks, highlighted by the new tariffs. The unconvincing U.S.-China tariff ceasefire agreed at the Osaka G20 has fallen apart as we expected; the period of “fire and fury” between the U.S. and Iran continues; and the U.S. is entering what we expect to be a period of socio-political instability in the lead up to the momentous 2020 presidential election. Moreover the risk of a “no deal” Brexit, in which the U.K. exits the European Union and reverts to basic World Trade Organization tariff levels, is rising and will create acute uncertainty over the next three months despite the world’s easy monetary policy settings (Charts 2A & 2B). In June we upgraded our odds of a no-deal Brexit to 21%, up from 7% this spring. While not our base case, the probability is too high for comfort and the critical timing for the rest of Europe warns against taking on additional risk. The risk of a “no deal” Brexit ... is rising and will create acute uncertainty. Chart 2AUncertainty And Sentiment Getting Worse ... Chart 2B... Despite Easy Monetary Policy BoJo’s Gambit Boris Johnson – aka “BoJo” – former mayor of London and foreign secretary, cemented his position as the U.K.’s 77th prime minister on July 24. He immediately launched a gambit to renegotiate the U.K.’s withdrawal. He is threatening not to pay the “divorce bill” (the U.K.’s outstanding budget contributions for the 2014-20 budget period and other liabilities in subsequent decades) of 39 billion pounds. He insists that the Irish backstop (which would keep Northern Ireland or the U.K. in the EU customs union to prevent a hard border between the two Irelands) must be abandoned. He has stacked his cabinet with pro-Brexit hardliners who share his “do or die” stance that Brexit must occur on October 31 regardless of whether an agreement for an orderly exit is in place. These developments were anticipated – hence the decline in our GeoRisk indicator – but the pound sterling is falling now that the confrontation is truly getting under way (Chart 3). Parliament is adjourned in August, so Johnson’s hardline negotiating tactics will get full play in the media cycle until early September, when the real showdown begins. Crunch time will likely run up to the eleventh hour, with Halloween marking an ominous deadline. There is plenty of room for the pound to fall further throughout this period, according to our European Investment Strategy’s handy measure (Chart 4), because the success of Boris’s gambit depends entirely upon creating a credible threat of crashing out of the EU in order to wring concessions that could conceivably pass through the British parliament. Chart 3Our Market-Based Indicator Suggests Still Some Complacency On Brexit Risks Chart 4GBP-EUR Still Has Room To Fall Under BoJo's Gambit Geopolitically, the United Kingdom is not prohibited from exiting the EU without a deal. Though the empire is a thing of the past, the U.K. remains a major world power. It has Europe’s second-largest economy, nuclear weapons, a blue-water navy, a leading voice in global political institutions, and is a close ally of the United States. It mints its own coin. It is a sovereign entity that can survive on its own just as Japan can survive on its own. This geopolitical foundation always supported our view that there was a 50% chance of the referendum passing in 2016, and today it supports the view that fears over a no-deal Brexit are not misplaced. Investors should therefore not confuse Johnson’s bluster with that of Alexis Tsipras in 2015. A British government dead-set on delivering this outcome – given the popular mandate from the 2016 referendum and the government’s constitutional handling of foreign affairs as opposed to parliament – can probably achieve it. However, the probability of a no-deal Brexit may become overstated in the next two-to-three months. Economically and politically, a no-deal exit is extremely difficult to follow through on – hence our 21% probability. Estimates of the negative economic impact range from a 2% reduction in GDP growth to an 11% reduction (Table 1). The 8% drop cited by Scottish National Party leader Ian Blackford in his denunciation of Prime Minister Johnson’s strategy is probably exaggerated. The U.K.’s recorded twentieth-century recessions range from 2%-7% (Chart 5). These offer as good of a benchmark as any. While a no-deal exit is probably not going to create a shock the same size as the Great Depression or the Great Recession, the recessions of 1979 and 1990 would be bad enough for any prime minister or ruling party. Table 1Wide Range Of Estimates For Impact Of No-Deal Brexit A small recession could also spiral out of control – it could create a vicious spiral with the European continent, which is already on the verge of recession. And it could damage consumer confidence more than anticipated – as it would be accompanied by immediate social and political unrest due to the half of the population that opposes Brexit in all forms. Politicians have to pay attention to the opinion polls as well as the referendum result, since opinion polls impact the next election. These show a plurality in favor of remaining in the EU and a strong trend against Brexit since 2017 – a factor that the currency markets are ignoring at the moment (Chart 6). While the evidence does not prove that a second referendum would result in Bremain, it is highly likely that a majority opposes a no-deal exit, given that at least a handful of pro-Brexit voters do not want to leave without a deal. The results of the European parliamentary elections in May (Chart 7) and the public’s preferences for different political parties (Chart 8) both support this conclusion. Chart 6Plurality Of Voters Still Favors Bremain Over Brexit Chart 8Voters Favor Bremain-Leaning Political Parties Parliament is also opposed to a no-deal Brexit. Though the Cooper-Letwin bill that forbad a no-deal exit initially passed by one vote in April (Chart 9A), the final amended version passed with a majority of 309 votes. Further, in July, with the rise of Boris Johnson, parliament passed a measure by 41 votes that requires parliament to sit this fall (Chart 9B), thus attempting to prevent Boris from proroguing parliament and forcing a no-deal Brexit that way. Technically Queen Elizabeth II could still prorogue parliament, but we highly doubt she would intervene in a way that would divide the nation. Johnson himself will have to face the reality of parliament and public opinion. Parliament has one crystal clear means of halting a no-deal exit: a vote of no confidence in Johnson’s government.1 Theresa May only survived her vote of no confidence by 19 seats. Yet Johnson is entering 10 Downing Street at a time when parliament is essentially hung. The Conservative Party’s coalition with Northern Ireland’s Democratic Union Party has been reduced to a majority of two, which is likely to fall to a single solitary seat after the Brecon and Radnorshire by-election, which is taking place as we go to press. Johnson has purged several Tories from his cabinet, and there are a handful of Conservatives who are firmly opposed to a no-deal Brexit. It would be an extremely tight vote as to whether these Tory rebels would be willing and able to bring down one of their own governments – a careful assessment suggests that there are about half a dozen swing voters on each side of the House of Commons.2 But 47 Conservatives contrived to block prorogation (see Chart 9B). The magnitude of the crisis members of parliament would face – an unpopular, self-inflicted no-deal exit and recession – is essential context that would motivate rebellious voting behavior. Parliament’s actions so far, the reality of the economic impact, and the popular polling suggest that MPs are likely to halt the Johnson government from forcing a no-deal exit if he makes a mad dash for it. More likely is that Johnson himself pushes to hold an election after securing some technical concessions from Brussels. He is galvanizing the Conservative vote and swallowing up the single-issue Brexit vote (UKIP and the Brexit Party), while the opposition remains divided between the Labour Party under the vacillating Jeremy Corbyn and the resurgent Liberal Democrats (Chart 10). In a first-past-the-post electoral system, this provides a window of opportunity for the Conservatives to improve their parliamentary majority – assuming that Johnson has renegotiated a deal with the EU and has something to show for it. Chart 10BoJo Could Call Election With Deal In Hand Chart 11Ireland Can Compromise For Stability's Sake This would require the EU to delay the deadline yet again (September 3 is the last date for a non-confidence vote to force a pre-Brexit October 24 election). The European Union has a self-interest in preventing a no-deal Brexit, as it needs to maintain economic stability. It ultimately would prefer to keep the U.K. in the bloc, which means that delays can ultimately be granted, especially to accommodate a new election. As to what kind of compromises are available, the Irish backstop can suffer technical changes to its provisions, time frames, or application. In the end, the Irish Sea is already a different kind of border than the other borders in the U.K. and therefore it is possible to enact additional checks that nevertheless have a claim to retaining the integrity of the United Kingdom. The Democratic Unionists could find themselves outnumbered on this issue. Certainly the Republic of Ireland has an interest in preventing a no-deal Brexit as long as a hard border with Northern Ireland is avoided, and Boris Johnson maintains that it will be (Chart 11). The risk of a no-deal Brexit is around 21% Our updated Brexit Decision Tree in Diagram 1 provides the outcomes. Former Prime Minister Theresa May failed three times to pass her Brexit deal. We allot a 30% chance, higher than consensus, that Boris Johnson can do it through galvanizing the Conservative vote – given that he is operating with a hung parliament and is at odds with the median voter on Brexit. We give 21% odds to a no-deal Brexit based on the difficulty of parliament outright halting Johnson if his government is absolutely determined to follow through with it. This is clearly a large risk but not our base case. We would upgrade these odds to around 30% in the event that negotiations with the EU completely fail to produce tangible outcomes. It is far more likely that a delay occurs and leads to new elections (49%) – and these odds rise to 70% if Johnson fails to extract concessions from the EU that enable him to pass a deal through parliament. Diagram 1Brexit Decision Tree (Updated As Of June 21 For Boris Johnson) A final constraint on Johnson comes from Scotland, as highlighted in the epigraph at the top of the report: the demand for a new Scottish independence referendum is reviving as a result of opposition to Brexit in general and specifically to Prime Minister Johnson’s hardline approach (Charts 12A & 12B). The SNP is also improving its favorability among Scottish voters relative to other parties (Chart 13). We have highlighted this risk in the past: support for Scottish independence does not have a clear ceiling amid the antagonism over Brexit, especially if an economic and political shock hits the union as a result of a forced no-deal exit. Chart 13Scottish Nationals Resurgent Bottom Line: The risk of a no-deal Brexit is around 21%, though a complete failure of negotiations with the EU could push it up to 30%. If it occurs it will induce a recession and eventually could result in the breakup of the union with Scotland. China And Investment Recommendations What can investors be certain of regardless of the different Brexit outcomes? The United Kingdom will reverse the fiscal austerity of recent years (Chart 14). Fiscal stimulus will be necessary either to offset the shock of a no-deal exit in the worst-case scenario, or to address the ongoing economic challenges and public grievances in a soft Brexit or no Brexit scenario. These grievances stem from the negative impact on the middle class of globalization, post-financial crisis deleveraging, low real wage growth, and the decline in productivity. Potential GDP growth is set to fall if immigration is curtailed and restrictions on trade with the EU go up. The government will have to offset this trend with spending to boost the social safety net and encourage investment. Chart 14Fiscal Austerity To Go Into Reverse The pound is clearly weak on a long-term and structural basis (Chart 15). Based on our assessment of the British median voter – opposed to a no-deal Brexit – and the fact that parliament is also opposed to a no-deal Brexit Chart 15Deep Value In Sterling and is the supreme lawgiving body in the British constitution, we expect that an enormous buying opportunity will emerge when Prime Minister Johnson’s gambit has reached its apex and he is either forced to accept what concessions the EU will give. But if forced out of office, election uncertainty due to a potential Prime Minister Jeremy Corbyn will prolong the pound’s weakness. Brexit is not the only risk affecting Europe this summer – a critical factor is Europe’s own economic status, which in great part hinges on our China view (Chart 16). The Chinese Communist Party’s mid-year Politburo meeting struck a more accommodative tone relative to the April meeting that sounded less dovish in the aftermath of the Q1 credit splurge. The emphasis of the remarks shifted back to the need to take additional measures to stabilize the economy, as in the October 2018 statement. This fits with our view since February that Chinese stimulus will surprise to the upside this year. Chart 16Chinese Reflation Positive For Europe Policymakers’ efforts are working thus far, with signs of stabilization occurring in the all-important labor market (Chart 17). There is some evidence that Xi Jinping’s anti-corruption campaign is moderating, which also supports the view that policy settings in the broadest sense are becoming more supportive of growth (Chart 18). Chart 17China Will Reflate More Chart 18Relaxing Anti-Corruption Campaign Another Form Of Easing Chart 19Hong Kong Equities Have Farther To Fall We still are long European equities versus Chinese equities and are short the CNY-USD. From a geopolitical point of view, the U.S.-China conflict is intensifying with President Trump’s threat to raise an additional 10% tariff on $300 billion of Chinese imports despite the resumption of talks. In addition, the Hong Kong protests are intensifying, with China’s People’s Liberation Army (PLA) warning that it may have to intervene. There is high potential for violence to erupt, leading to a more heavy-handed approach by Hong Kong security forces and even eventual PLA deployment. This suggests there is downside in the Hang Seng index (Chart 19) – and PLA intervention could lead to broader investor concerns about China’s internal stability and another reason for tensions with the United States and its allies. The U.S.-China conflict is intensifying. Our alarmist view on Taiwan in advance of the January 2020 election is finally taking shape. Not only has the Hong Kong unrest prompted a notable uptick in Taiwanese people’s view of themselves as exclusively Taiwanese (Chart 20), but Beijing has also announced additional restrictions on travel and tourism to Taiwan – an economic sanction that will harm the economy (Chart 21). These actions and escalation in Hong Kong raise the odds that the ruling Democratic Progressive Party will remain in power in Taiwan after January and hence that cross-strait relations (and by extension Sino-American relations) will remain strained and will require a higher risk premium to be built in. The latest trade war escalation could easily spill into strategic saber-rattling, as the U.S. blames China for North Korea’s return to bad behavior and China blames the U.S. for dissent in Hong Kong and likely Taiwan. Chart 21Beijing To Sanction Taiwan Tourism Again The U.S.-China trade negotiations are falling apart at the moment. We had argued that China’s stimulus and stabilization would create a negative reaction from President Trump, who would regret the Osaka ceasefire when he saw that China’s bargaining leverage had improved. This has come to pass, vindicating our 60% odds of an escalation post-G20. The U.S. Commerce Department could still conceivably renew the Temporary General License for U.S. companies to deal with Chinese tech firm Huawei on August 19, in order to create an environment conducive to progress for the next round of trade talks in September, but with the latest round of tariffs we think it is more likely that we will get a major escalation of strategic tensions and even saber-rattling. China’s new announcements regarding reforms to make local officials more accountable and to make it easier for companies to go bankrupt, including unprofitable “zombie” state-owned enterprises, could be a thinly veiled structural concession to the United States, but it remains to be seen whether these will be implemented and reinforced. Beijing rebooted structural reforms at the nineteenth national party congress but we expect stimulus to overwhelm reform amid trade war. We are converting our long non-Chinese rare earth producers recommendation to a strategic trade, after it hit our 5% stop-loss, as it is supported by our major theme of Sino-American strategic rivalry. The secular nature of this rivalry has been greatly confirmed by the fact that President Trump is now responding to American election dynamics. The U.S. Democratic Party’s primary debates have revealed that the candidates most likely to take on President Trump (Bernie Sanders and Elizabeth Warren) are adopting his hawkish foreign policy and trade policy stance toward China. The frontrunner former Vice President Joe Biden is the exception, as he is maintaining President Obama’s more dovish and multilateral approach. Trump’s clear response is to ensure that he still owns the trade and manufacturing narrative, to call Biden weak on trade, and to prevent the left-wing populists from outflanking him. Short the Hang Seng index as a tactical trade and close long Q1 2020 Brent futures versus Q1 2021 at the market bell tonight. Matt Gertken, Vice President Geopolitical Strategist mattg@bcaresearch.com Footnotes 1 See Maddy Thimont Jack, “A New Prime Minister Intent On No Deal Brexit Can’t Be Stopped By MPs,” May 22, 2019, www.instituteforgovernment.org.uk. 2 See Dominic Walsh, “Would MPs really back a no confidence motion to stop no-deal?” The New Statesman, July 15, 2019, www.newstatesman.com.
Highlights So What? Economic stimulus will encourage key nations to pursue their self-interest – keeping geopolitical risk high. Why? The U.S. is still experiencing extraordinary strategic tensions with China and Iran … simultaneously. The Trump-Xi summit at the G20 is unlikely to change the fact that the United States is threatening China with total tariffs and a technology embargo. The U.S. conflict with Iran will be hard to keep under wraps. Expect more fireworks and oil volatility, with a large risk of hostilities as long as the U.S. maintains stringent oil sanctions. All of our GeoRisk indicators are falling except for those of Germany, Turkey and Brazil. This suggests the market is too complacent. Maintain tactical safe-haven positioning. Feature “That’s some catch, that Catch-22,” he observed. “It’s the best there is,” Doc Daneeka agreed. -Joseph Heller, Catch-22 (1961) One would have to be crazy to go to war. Yet a nation has no interest in filling its military’s ranks with lunatics. This is the original “Catch-22,” a conundrum in which the only way to do what is individually rational (avoid war) is to insist on what is collectively irrational (abandon your country). Or the only way to defend your country is to sacrifice yourself. This is the paradox that U.S. President Donald Trump faces having doubled down on his aggressive foreign policy this year: if he backs away from trade war to remove an economic headwind that could hurt his reelection chances, he sacrifices the immense leverage he has built up on behalf of the United States in its strategic rivalry with China. “Surrender” would be a cogent criticism of him on the campaign trail: a weak deal will cast him as a pluto-populist, rather than a real populist – one who pandered to China to give a sop to Wall Street and the farm lobby just like previous presidents, yet left America vulnerable for the long run. Similarly, if President Trump stops enforcing sanctions against Iranian oil exports to reduce the threat of a conflict-induced oil price shock that disrupts his economy, then he reduces the United States’s ability to contain Iran’s nuclear and strategic advances in the wake of the 2015 nuclear deal that he canceled. The low appetite for American involvement in the region will be on full display for the world to see. Iran will have stared down the Great Satan – and won. In both cases, Trump can back down. Or he can try to change the subject. But with weak polling and yet a strong economy, the point is to direct voters’ attention to foreign policy. He could lose touch with his political base at the very moment that the Democrats reconnect with their own. This is not a good recipe for reelection. More important – for investors – why would he admit defeat just as the Federal Reserve is shifting to countenance the interest rate cuts that he insists are necessary to increase his economic ability to drive a hard bargain with China? Why would he throw in the towel as the stock market soars? And if Trump concludes a China deal, and the market rises higher, will he not be emboldened to put more economic pressure on Mexico over border security … or even on Europe over trade? The paradox facing investors is that the shift toward more accommodative monetary policy (and in some cases fiscal policy) extends the business cycle and encourages political leaders to pursue their interests more intently. China is less likely to cave to Trump’s demands as it stimulates. The EU does not need to fear a U.K. crash Brexit if its economy rebounds. This increases rather than decreases the odds of geopolitical risks materializing as negative catalysts for the market. Similarly, if geopolitical risk falls then the need for stimulus falls and the market will be disappointed. The result is still more volatility – at least in the near term. The G20 And 2020 As we go to press the Democratic Party’s primary election debates are underway. The progressive wave on display highlights the overarching takeaway of the debates: the U.S. election is now an active political (and geopolitical) risk to the equity market. A truly positive surprise at the G20 would be a joint statement by Trump and Xi plus some tariff rollback. Whenever Trump’s odds of losing rise, the U.S. domestic economy faces higher odds of extreme policy discontinuity and uncertainty come 2021, with the potential for a populist-progressive agenda – a negative for financials, energy, and probably health care and tech. Yet whenever Trump’s odds of winning rise, the world faces higher odds of an unconstrained Trump second term focusing on foreign and trade policy – a potentially extreme increase in global policy uncertainty – without the fiscal and deregulatory positives of his first term. We still view Trump as the favored candidate in this race (at 55% chance of reelection), given that U.S. underlying domestic demand is holding up and the labor market has not been confirmed to be crumbling beneath the consumer’s feet. Still Chart 1 highlights that Trump’s shift to more aggressive foreign and trade policy this spring has not won him any additional support – his approval rating has been flat since then. And his polling is weak enough in general that we do not assign him as high of odds of reelection as would normally be afforded to a sitting president on the back of a resilient economy. This raises the question of whether the G20 will mark a turning point. Will Trump attempt to deescalate his foreign conflicts? Yes, and this is a tactical opportunity. But we see no final resolution at hand. With China, Trump’s only reason to sign a weak deal would be to stem a stock market collapse. With Iran, Trump is no longer in the driver’s seat but could be forced to react to Iranian provocations. Bottom Line: Trump’s polling has not improved – highlighting the election risk – but weak polling amid a growing economy and monetary easing is not a recipe for capitulating to foreign powers. The Trump-Xi Summit On China the consensus on the G20 has shifted toward expecting an extension of talks and another temporary tariff truce. If a new timetable is agreed, it may be a short-term boon for equities. But we will view it as unconvincing unless it is accompanied with a substantial softening on Huawei or a Trump-Xi joint statement outlining an agreement in principle along with some commitment of U.S. tariff rollback. Otherwise the structural dynamic is the same: Trump is coercing China with economic warfare amid a secular increase in U.S.-China animosity that is a headwind for trade and investment. Table 1 shows that throughout the modern history of U.S.-China presidential-level summits, the Great Recession marked a turning point: since then, bilateral relations have almost always deteriorated in the months after a summit, even if the optics around the summit were positive. Table 1U.S.-China Leaders Summits: A Chronology The last summit in Buenos Aires was no exception, given that the positive aura was ultimately followed by a tariff hike and technology-company blacklistings. Of course, the market rallied for five months in between. Why should this time be the same? First, the structural factors undermining Sino-American trust are worse, not better, with Trump’s latest threats to tech companies. Second, Trump will ultimately resent any decision to extend the negotiations. China’s economy is rebounding, which in the coming months will deprive Trump of much of the leverage he had in H2 2018 and H1 2019. He will be in a weaker position if they convene in three months to try to finalize a deal. Tariff rollback will be more difficult in that context given that China will be in better shape and that tariffs serve as the guarantee that any structural concessions will be implemented. Bottom Line: Our broader view regarding the “end game” of the talks – on the 2020 election horizon – remains that China has no reason to implement structural changes speedily for the United States until Trump can prove his resilience through reelection. Yet President Trump will suffer on the campaign trail if he accepts a deal that lacks structural concessions. Hence we expect further escalation from where we are today, knowing full well that the G20 could produce a temporary period of improvement just as occurred on December 1, 2018. The Iran Showdown Is Far From Over Disapproval of Trump’s handling of China and Iran is lower than his disapproval rating on trade policy and foreign policy overall, suggesting that despite the lack of a benefit to his polling, he does still have leeway to pursue his aggressive policies to a point. A breakdown of these opinions according to key voting blocs – a proxy for Trump’s ability to generate support in Midwestern swing states – illustrates that his political base is approving on the whole (Chart 2). Yet the conflict with Iran threatens Trump with a hard constraint – an oil price shock – that is fundamentally a threat to his reelection. Hence his decision, as we expected, to back away from the brink of war last week (he supposedly canceled air strikes on radar and missile installations at the last minute on June 21). He appears to be trying to control the damage that his policy has already done to the 2015 U.S.-Iran equilibrium. Trump has insisted he does not want war, has ruled out large deployments of boots on the ground, and has suggested twice this week that his only focus in trying to get Iran back into negotiations is nuclear weapons. This implies a watering down of negotiation demands to downplay Iran’s militant proxies in the region – it is a retreat from Secretary of State Mike Pompeo’s more sweeping 12 demands on Iran and a sign of Trump’s unwillingness to get embroiled in a regional conflict with a highly likely adverse economic blowback. The Iran confrontation is not over yet – policy-induced oil price volatility will continue. This retreat lacks substance if Trump does not at least secretly relax enforcement of the oil sanctions. Trump’s latest sanctions and reported cyberattacks are a sideshow in the context of an attempted oil embargo that could destabilize Iran’s entire economy (Charts 3 and 4). Similarly, Iran’s downing of a U.S. drone pales in comparison to the tanker attacks in Hormuz that threatened global oil shipments. What matters to investors is the oil: whether Iran is given breathing space or whether it is forced to escalate the conflict to try to win that breathing space. Chart 4Iran’s Rial Depreciated Sharply The latest data suggest that Iran’s exports have fallen to 300,000 barrels per day, a roughly 90% drop from 2018, when Trump walked away from the Iran deal. If this remains the case in the wake of the brinkmanship last week then it is clear that Iran is backed into a corner and could continue to snarl and snap at the U.S. and its regional allies, though it may pause after the tanker attacks. Chart 5More Oil Volatility To Come Tehran also has an incentive to dial up its nuclear program and activate its regional militant proxies in order to build up leverage for any future negotiation. It can continue to refuse entering into negotiations with Trump in order to embarrass him – and it can wait until Trump’s approach is validated by reelection before changing this stance. After all, judging by the first Democratic primary debate, biding time is the best strategy – the Democratic candidates want to restore the 2015 deal and a new Democratic administration would have to plead with Iran, even to get terms less demanding than those in 2015. Other players can also trigger an escalation even if Presidents Trump and Rouhani decide to take a breather in their conflict (which they have not clearly decided to do). The Houthi rebels based in Yemen have launched another missile at Abha airport in Saudi Arabia since Trump’s near-attack on Iran, an action that is provocative, easily replicable, and not necessarily directly under Tehran’s control. Meanwhile OPEC is still dragging its feet on oil production to compensate for the Iranian losses, implying that the cartel will react to price rises rather than preempt them. The Saudis could use production or other means to stoke conflict. Bottom Line: Given our view on the trade war, which dampens global oil demand, we expect still more policy-induced volatility (Chart 5). We do not see oil as a one-way bet … at least not until China’s shift to greater stimulus becomes unmistakable. North Korea: The Hiccup Is Over Chart 6China Ostensibly Enforces North Korean Sanctions The single clearest reason to expect progress between the U.S. and China at the G20 is the fact that North Korea is getting back onto the diplomatic track. North Korea has consistently been shown to be part of the Trump-Xi negotiations, unlike Taiwan, the South China Sea, Xinjiang, and other points of disagreement. General Secretary Xi Jinping took his first trip to the North on June 20 – the first for a Chinese leader since 2005 – and emphasized the need for historic change, denuclearization, and economic development. Xi is pushing Kim to open up and reform the economy in exchange for a lasting peace process – an approach that is consistent with China’s past policy but also potentially complementary with Trump’s offer of industrialization in exchange for denuclearization. President Trump and Kim Jong Un have exchanged “beautiful” letters this month and re-entered into backchannel discussions. Trump’s visit to South Korea after the G20 will enable him and President Moon Jae-In to coordinate for a possible third summit between Trump and Kim. Progress on North Korea fits our view that the failed summit in Hanoi was merely a setback and that the diplomatic track is robust. Trump’s display of a credible military threat along with Chinese sanctions enforcement (Chart 6) has set in motion a significant process on the peninsula that we largely expect to succeed and go farther than the consensus expects. It is a long-term positive for the Korean peninsula’s economy. It is also a positive factor in the U.S.-China engagement based on China’s interest in ultimately avoiding war and removing U.S. troops from the peninsula. From an investment point of view, an end to a brief hiatus in U.S.-North Korean diplomacy is a very poor substitute for concrete signs of U.S.-China progress on the tech front or opening market access. There has been nothing substantial on these key issues since Trump hiked the tariff rate in May. As a result, it is perfectly possible for the G20 to be a “success” on North Korea but, like the Buenos Aires summit on December 1, for markets to sell the news (Chart 7). Chart 7The Last Trade Truce Didn't Stop The Selloff Chart 8China Needs A Final Deal To Solve This Problem Bottom Line: North Korea is not a basis in itself for tariff rollback, but only as part of a much more extensive U.S.-China agreement. And a final agreement is needed to improve China’s key trade indicators on a lasting basis, such as new export orders and manufacturing employment, which are suffering amid the trade war. We expect economic policy uncertainty to remain elevated given our pessimistic view of U.S.-China trade relations (Chart 8). What About Japan, The G20 Host? Japan faces underrated domestic political risk as Prime Minister Abe Shinzo approaches a critical period in his long premiership, after which he will almost certainly be rendered a “lame duck,” likely by the time of the 2020 Tokyo Olympics. The question is when will this process begin and what will the market impact be? If Abe loses his supermajority in the July House of Councillors election, then it could begin as early as next month. This is a real risk – because a two-thirds majority is always a tall order – but it is not extreme. Abe’s polling is historically remarkable (Chart 9). The Liberal Democratic Party and its coalition partner Komeito are also holding strong and remain miles away from competing parties (Chart 10). The economy is also holding up relatively well – real wages and incomes have improved under Abe’s watch (Chart 11). However, the recent global manufacturing slowdown and this year’s impending hike to the consumption tax in October from 8% to 10% are killing consumer confidence. Chart 10Japan's Ruling Coalition Is Strong The collapse in consumer confidence is a contrary indicator to the political opinion polling. The mixed picture suggests that after the election Abe could still backtrack on the tax hike, although it would require driving through surprise legislation. He can pull this off in light of global trade tensions and his main objective of passing a popular referendum to revise the constitution and remilitarize the country. Chart 11Japanese Wages Up, But Consumer Confidence Diving We would not be surprised if Japan secured a trade deal with the U.S. prior to China. Because Abe and the United States need to enhance their alliance, we continue to downplay the risk of a U.S.-Japan trade war. Bloomberg recently reported that President Trump was threatening to downgrade the U.S.-Japan alliance, with a particular grievance over the ever-controversial issue of the relocation of troops on Okinawa. We view this as a transparent Trumpian negotiating tactic that has no applicability – indeed, American military and diplomatic officials quickly rejected the report. We do see a non-trivial risk that Trump’s rhetoric or actions will hurt Japanese equities at some point this year, either as Trump approaches his desired August deadline for a Japan trade deal or if negotiations drag on until closer to his decision about Section 232 tariffs on auto imports on November 14. But our base case is that there will be either no punitive measures or only a short time span before Abe succeeds in negotiating them away. We would not be surprised if the Japanese secured a deal prior to any China deal as a way for the Trump administration to try to pressure China and prove that it can get deals done. This can be done because it could be a thinly modified bilateral renegotiation of the Trans-Pacific Partnership, which had the U.S. and Japan at its center. Bottom Line: Given the combination of the upper house election, the tax hike and its possible consequences, a looming constitutional referendum which poses risks to Abe, and the ongoing external threat of trade war and China tensions, we continue to see risk-off sentiment driving Japanese and global investors to hold then yen. We maintain our long JPY/USD recommendation. The risk to this view is that Bank of Japan chief Haruhiko Kuroda follows other central banks and makes a surprisingly dovish move, but this is not warranted at the moment and is not the base case of our Foreign Exchange Strategy. GeoRisk Indicators Update: June 28, 2019 Our GeoRisk indicators are sending a highly complacent message given the above views on China and Iran. All of our risk measures, other than our German, Turkish, and Brazilian indicators, are signaling a decrease geopolitical tensions. Investors should nonetheless remain cautious: Our German indicator, which has proven to be a good measure of U.S.-EU trade tensions, has increased over the first half of June (Chart 12). We expect Germany to continue to be subject to risk because of Trump’s desire to pivot to European trade negotiations in the wake of any China deal. The auto tariff decision was pushed off until November. We assign a 45% subjective probability to auto tariffs on the EU if Trump seals a final China deal. The reason it is not our base case is because of a lack of congressional, corporate, or public support for a trade war with Europe as opposed to China or Mexico, which touch on larger issues of national interest (security, immigration). There is perhaps a 10% probability that Trump could impose car tariffs prior to securing a China deal. Chart 12U.S.-EU Trade Tensions Hit Germany Chart 13German Greens Overtaking Christian Democrats! Germany is also an outlier because it is experiencing an increase in domestic political uncertainty. Social Democrat leader Andrea Nahles’ resignation on June 2 opened the door to a leadership contest among the SPD’s membership. This will begin next week and conclude on October 26, or possibly in December. The result will have consequences for the survivability of Merkel’s Grand Coalition – in case the SPD drops out of it entirely. Both Merkel and her party have been losing support in recent months – for the first time in history the Greens have gained the leading position in the polls (Chart 13). If the coalition falls apart and Merkel cannot put another one together with the Greens and Free Democrats, she may be forced to resign ahead of her scheduled 2021 exit date. The implication of the events with Trump and Merkel is that Germany faces higher political risk this year, particularly in Q4 if tariff threats and coalition strains coincide. Meanwhile, Brazilian pension reform has been delayed due to an inevitable breakdown in the ability to pass major legislation without providing adequate pork barrel spending. As for the rest of Europe, since European Central Bank President Mario Draghi’s dovish signal on June 18, all of our European risk indicators have dropped off. Markets rallied on the news of the ECB’s preparedness to launch another round of bond-buying monetary stimulus if needed, easing tensions in the region. Italian bond spreads plummeted, for instance. The Korean and Taiwanese GeoRisk indicators, our proxies for the U.S.-China trade war, are indicating a decrease in risk as the two sides moved to contain the spike in tensions in May. While Treasury Secretary Steve Mnuchin notes that the deal was 90% complete in May before the breakdown, there is little evidence yet that any of the sticking points have been removed over the past two weeks. These indicators can continue to improve on the back of any short-term trade truce at the G20. The Russian risk indicator has been hovering in the same range for the past two months. We expect this to break out on the back of increasing mutual threats between the U.S. and Russia. The U.S. has recently agreed to send an additional 1000 rotating troops to Poland, a move that Russia obviously deems aggressive. The Russian upper chamber has also unanimously supported President Putin’s decree to suspend the Intermediate Nuclear Forces treaty, in the wake of the U.S. decision to do so. This would open the door to developing and deploying 500-5500 km range land-based and ballistic missiles. According to the deputy foreign minister, any U.S. missile deployment in Europe will lead to a crisis on the level of the Cuban Missile Crisis. Russia has also sided with Iran in the latest U.S.-Iran tension escalation, denouncing U.S. plans to send an additional 1000 troops to the Middle East and claiming that the shot-down U.S. drone was indeed in Iranian airspace. We anticipate the Russian risk indicator to go up as we expect Russia to retaliate in some way to Poland and to take actions to encourage the U.S. to get entangled deeper into the Iranian imbroglio, which is ultimately a drain on the U.S. and a useful distraction that Russia can exploit. In Turkey, both domestic and foreign tensions are rising. First, the re-run of the Istanbul mayoral election delivered a big defeat for Turkey’s President Erdogan on his home turf. Opposition representative Ekrem Imamoglu defeated former Prime Minister Binali Yildirim for a second time this year on June 23 – increasing his margin of victory to 9.2% from 0.2% in March. This was a stinging rebuke to Erdogan and his entire political system. It also reinforces the fact that Erdogan’s Justice and Development Party (AKP) is not as popular as Erdogan himself, frequently falling short of the 50% line in the popular vote for elections not associated directly with Erdogan (Chart 14). This trend combined with his personal rebuke in the power base of Istanbul will leave him even more insecure and unpredictable. Second, the G20 summit is the last occasion for Erdogan and Trump to meet personally before the July 31 deadline on Erdogan’s planned purchase of S-400 missile defenses from Russia. Erdogan has a chance to delay the purchase as he contemplates cabinet and policy changes in the wake of this major domestic defeat. Yet if Erdogan does not back down or delay, the U.S. will remove Turkey from the F-35 Joint Strike Fighter program, and may also impose sanctions over this purchase and possibly also Iranian trade. The result will hit the lira and add to Turkey’s economic woes. Geopolitically, it will create a wedge within NATO that Russia could exploit, creating more opportunities for market-negative surprises in this area. Finally, we expect our U.K. risk indicator to perk up, as the odds of a no-deal Brexit are rising. Boris Johnson will likely assume Conservative Party leadership and the party is moving closer to attempting a no-deal exit. We assign a 21% probability to this kind of Brexit, up from our previous estimate of 14%. It is more likely that Johnson will get a deal similar to Theresa May’s deal passed or that he will be forced to extend negotiations beyond October. Matt Gertken, Vice President Geopolitical Strategist mattg@bcaresearch.com Ekaterina Shtrevensky, Research Analyst ekaterinas@bcaresearch.com France: GeoRisk Indicator U.K.: GeoRisk Indicator Germany: GeoRisk Indicator Italy: GeoRisk Indicator Spain: GeoRisk Indicator Russia: GeoRisk Indicator Korea: GeoRisk Indicator Taiwan: GeoRisk Indicator Turkey: GeoRisk Indicator Brazil: GeoRisk Indicator What's On The Geopolitical Radar? Section III: Geopolitical Calendar