In this article we look at recent commentary coming out of BCA Research’s Daily Insights notes, with particular focus on geopolitical risk, China’s growth outlook and the prospects of a US recession.
Geopolitical risk
Geopolitical instability is making a comeback in the market after being relatively quiet for most of 2023. Global investors are now recognizing the arguments put forth by BCA Research’s geopolitical experts throughout the year. They’ve been highlighting the growing geopolitical risks as a secular trend, driven by the challenges posed by Russia, China, and Iran to the US-led global order, as well as the internal divisions within the United States, which have hindered a cohesive strategic response.
These factors are expected to intensify in the coming months due to several developments, including the escalating proxy conflict between Iran and Israel, Ukraine’s struggles in countering Russia, Taiwan’s upcoming 2024 election, and the likely nomination of former President Trump as the Republican presidential candidate.
In the short term, the risk of an oil supply disruption is on the rise as the United States is increasing its military presence in the Middle East in response to attacks on US bases by Iranian-backed militias. According to our BCA Research, there is approximately a 30% subjective risk that the conflict in Gaza could spread to oil-producing regions like Iraq, the Persian Gulf, and Iran. They argue that the primary source of instability in the Middle East is Iran’s potential nuclear breakout.
The instability in the Middle East, coupled with Russia’s use of energy as a political tool, significantly raises the chances of a substantial oil supply shortage affecting the global economic outlook in 2024.
The Biden administration will explore ways to boost oil production, but its options are limited. Without a new strategic understanding between the US and Saudi Arabia, it is likely that Saudi Arabia will increase oil production inadequately or too late, if at all.
China growth outlook
Despite the recent string of better-than-expected economic data releases which includes upside surprises from GDP growth, retail sales, industrial production, and exports, China’s financial markets continue to deteriorate, highlighting investor pessimism about the growth outlook.
The decline in Chinese risk assets is occurring despite continued efforts to bolster the economy through selective and specific policy support measures. These trends underscore the fact that investors are not anticipating substantial economic recovery resulting from stimulus measures. In fact, our China Investment experts have stressed that Beijing’s objective is to stabilize the economy rather than potentially exacerbate existing macroeconomic imbalances by implementing significant policy stimulus. Therefore, positive surprises in economic data make it less likely that sweeping stimulus measures akin to “irrigation-style” interventions will be introduced. This suggests that while economic growth is not in a state of collapse, it also isn’t on the verge of a substantial improvement.
Prospects of a US recession (from the US banking sector’s perspective)
Looking at the Systemically Important Financial Institutions (SIFIs) earnings calls, BCA Research found nothing in the banks’ remarks indicating an impending recession. The study focussed on borrower performance, lender willingness, liquidity and the actions and intentions of households and businesses.
Both households and businesses continue to stand on a stable foundation, boasting substantial cash reserves and an absence of any significant surge in credit demand. While consumer delinquencies are approaching pre-pandemic levels, they haven’t quite reached that point yet. Business write-offs remain exceptionally low, household spending is gradually tapering off, and consumer deposits remain high. Banks have set aside more reserves for potential loan losses, but they do not perceive a broader deterioration in credit performance. This increase in reserves is primarily due to the growth in credit card balances and slightly elevated anticipated losses on business loans.
The banks’ observations align with the BCA Research team’s belief that a recession might commence sometime in the first half of 2024.
All these indicators point to a generalised “risk-off” perspective within the financial markets. This tends to lead to the US dollar remaining strong with a negative disposition towards risk assets such as emerging market currencies, including the rand. However, any positive news or data releases that point to an improvement in the global economy have caused periodic “bounces” in the value of the rand. It is therefore critical that those businesses that are exposed to exchange rate risk follow a systematic risk-based approach to managing their foreign currency exposures.
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