From the CEO – November 2018
As I mentioned on CNBC last month – and repeated several times in the press and in our reports – the real political risk facing British prime minister, Theresa May, wasn’t getting a deal with the EU on the terms of her country’s exit from the union but selling the product at home. I also said at the time that a deal with the EU was closer than we were being led to believe in the press.
By the end of November, this outlook was prescient. The release of the 585-page deal, which involves citizens’ rights, the cost of the exit, and the issue of avoiding a ‘hard’ border with Ireland, was met with all sorts of opposition. From being characterized as ‘a waste of time’ and ‘the worst of all worlds,’ even President Trump chimed in, suggesting that it wasn’t clear whether the agreement would allow a US-UK trading partnership. There was talk of replacing May as prime minister.
The thorniest of issues, of course, remains the question of the Irish border. The UK government initially proposed a sort of ‘technological’ solution, but nobody really bought it. Conversely, the EU proposed that Northern Ireland stay in the single market and customs union, which caused smoke to billow from May’s ears, unsurprisingly.
So, what was eventually proposed is a backstop, or insurance plan, that comes into effort if future trade talks fail, designed to avoid the ‘hard border’. This means that the UK would remain in the customs union, while Northern Ireland would follow single market rules. Brexit supporters said the section would keep the UK tied to the EU’s rules, while others suggested it would benefit UK firms disproportionately, and insisted that the UK adhere to EU social and environmental rules in an effort to keep a level playing field with non-UK companies.
May is now out touring the country in an effort to save the deal. And while the opposition in the Commons remains formidable, it appears that at least some of the voting public is buying her message. Public opinion polls have begun to improve for the prime minister, with considerable support for her being the best choice to prime minister at this time. Citizen support for the deal, especially among Labor supporters and those that voted for the Remain side, is also mounting, although the country remains deeply divided on the issue.
Our models are not expecting a hard Brexit for the UK, but rather some kind of arrangement– a workable compromise, as it were – similar to the deal put forth by May, to be accepted eventually by parliament.
To be sure, parliamentary acceptance might not be done the first time around, since May does not seem to have the votes at the moment. But the furor and anxiety that would likely result given the prospect of having no deal should eventually bring all sides together. Some have suggested stopping the clock on Article 50 to give all sides more time to agree on a solution before a hasty exit. Others have suggested another referendum if a slightly new agreement cannot be accepted.
Part of the problem with the first referendum is that there really wasn’t a clear idea what exiting from the EU would really entail. The UK public is now getting a better understanding, so a second referendum would at least be decided on a more informed basis.
Turning to the US, it seems that monetary policy will ease in the coming year as the most recent address by the Fed Chairman, Jerome Powell, suggested that the bank’s policy rate is now ‘just below’ estimates of a ‘neutral level.’ The markets saw this as a signal that the Fed’s three-year tightening cycle is coming to an end, and equities rose pretty much across the board.
Powell’s comments were quite distinct from those he made in October, when he suggested that the key interest rates were a ‘long way’ from the neutral level and that more tightening was in the cards. Perhaps some of the jawboning from President Trump helped matters? I would agree they had some effect, similar to taper tantrum of 2013, when the markets pushed back against the Fed.
To be sure, some on Wall Street are suggesting that Powell’s comments on the neutral rate were misinterpreted, adding that the Chairman was only stating that the current rate was near the ‘range’ of estimates from the Fed’s individual policy-makers (which is reportedly between 2.5% and 3.5%).
Either way, the path ahead is for a pause in rate hikes – most likely in early 2019 – and this bodes well for emerging markets, which have been pummeled this year under the Fed tightening cycle. On the short side, the USD should weaken against the euro and other major currencies next year and into 2020. Gold will also likely rise but it is a bet I don’t particularly like to make.
Turning to the ICRG ratings for November, several notable risk-related themes or patterns stand out. First, consumer confidence levels generally continue to slide in much of Europe. We identified this during the late spring, early summer months and, given the slowdown in the global economy, it is not surprising. Belgium, Denmark, Estonia, Portugal, and Spain all had their confidence risk ratings adjusted downward (meaning more risk) in November.
France also had some negative adjustments to its overall political risk score, as President Macron’s popularity is down considerably from his early months in office, made worse by the largest anti-government protests in Paris since the president’s assumption of power. The protests are largely over rising fuel taxes and inadequate spending power in the face of the increases. Macron did suggest that he would consider some kind of mechanism to adjust tax increase if prices were being elevated due to higher costs for global crude. Macron also called for a national consultation process to begin that would chart the way for accelerating the country’s transition away from fossil fuels, which remains largely the reason fuel costs are so high.
Expect the protests to continue into 2019.
Second, Africa remains one of the brighter spots in the emerging market asset class, with credits such as Botswana, Ghana, Sierra Leone and South Africa leading the way, either in the ‘Low Risk’ or low “Moderate Risk’ category. I’ve mentioned these countries before as some of the emerging markets that fared better than most during the rout of the asset class over the course of this year.
On the downside, however, delays to the vote have not helped ease the risk of ‘Internal Conflict” in Guinea Bissau, nor have higher fuel costs and a weakening currency in Liberia done much to ease social tensions and the government’s overall support levels.
Third, Latin America remains interesting as several countries remain in the ‘High Risk’ and ‘Very High Risk’ categories but others are staging a ‘risk-comeback’ of sorts. The former includes credits such as Venezuela, Nicaragua, and Haiti. On the latter, despite some promise last year of a more stable country, much of Port-au-Prince has been subject to the protests of thousands expressing their outrage over what is seen as widespread corruption and an economy that continues to sputter, to put it mildly. This is the development trajectory of Haiti and we don’t see an end to the malaise anytime soon, unfortunately.
On the bright side, we see improvements in the risk profiles of Argentina and Brazil continuing into 2019, complete with all of the advantages that would be gained by select long position in those country’s equities and currencies.
On the topic of corruption, I will be addressing Kazakhstan’s December conference, titled ‘East-West: Bridging Anti-Corruption Efforts.’ The gathering will be held under the auspices of the Agency of the Republic of Kazakhstan for Civil Service Affairs and Anti-Corruption, and will provide an opportunity for attendees and others to analyze current anti-corruption trends and efforts, evaluate innovations at the legislative level.
The Agency has consulted with PRS extensively over the past year and has done a very good job at keeping us up to date on the various developments taking place to eradicate graft in government and in business dealings in the country.
Finally, I’ll be in New York City next week for client meetings, with a special time reserved for one firm that is working heavily in the artificial intelligence and machine learning fields. As most clients and friends know, ICRG’s data series have already been subjected to a number of machine learning applications and the preliminary results have been very promising. We hope to take this to the next level, complete with some proprietary software, and truly offer clients a heightened level of insight into political risk and asset class behavior and pricing that cannot be found anywhere else.
Thanks for your continued support, and please contact us if we can be of any assistance.
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