Geopolitics is an increasingly relevant risk for the global economy
The prevailing backdrop of social unrest and war has reached its peak in the last quarter when looked at in the context of the last few decades, making global governance and geopolitics one of the most evident risks for the global economy in the fourth quarter of the year, according to MAPFRE Economics in its Economic and industry outlook 2023: fourth quarter perspectives report.
The Middle East crisis that began in early October resulted in an institutional mobilization favorable to Israel, which contrasts with a partisan reading, popular in Europe and less so in the United States. The differences and ideological partisanism caused by the conflict have been aggravated by the start of Phase II of the Israeli land campaign.
There is therefore a real risk that the conflict will spread further in the region and cause a crisis in the Middle East, similar to that experienced in the 1970s with the Yom Kippur War.
However, for now, the markets have not reflected this situation. The gold/copper ratio, a risk aversion measure, is currently at its historical average. The unconditional support of the United States for Israel has raised doubts about the sustainability of simultaneous support to Ukraine. The reordering of the priorities of a Democratic Congress, or the reinforcement of the US vision, would detract from the full contribution to the cause of Ukraine, so the crisis there would have a more accurate and approachable end over time.
With regard to the conflict between Ukraine and Russia, two elements are at stake, despite the tactical stagnation of the war. The first is Donald Tusk's potential new Polish government and the second is the progress of conversations to define what a post-war situation would look like. Although Russia did not participate in the meeting, the increase in participants and the reduction in the number of countries that had not yet taken a position offers some hope to Ukraine.
In addition, warlike tensions in the Middle East, together with production cuts by the Organization of Petroleum Exporting Countries (OPEC), have brought oil prices back up to 90 USD/bl. The price of natural gas has also increased by 20% to 50 EUR/MWh last month, although it is still far from the peak of 2022, which reached 292 EUR/MWh. Sustained higher prices would have an impact on inflation dynamics through a new supply shock.
The resolution of geopolitical conflicts, together with less penalizing policies toward fossil fuels, would currently be determining factors for the moderation of energy price growth and, consequently, the fight against inflation in the short term.
Inflation, financial risk and global debt
Over the last few months, inflation data have continued to moderate downward, mainly in terms of producer and underlying prices, although the general downward trend was halted in some countries due to the effect of the energy price component. Looking ahead to the coming quarters, inflation is expected to continue to moderate as a result of restrictive monetary policy but will be counterbalanced by the possible upturn in energy prices and the effects of ongoing salary negotiations.
In terms of financial risk, global aggregate debt at the end of the second quarter of 2023 reached 307.1 trillion dollars, accounting for nearly 336% of global GDP, up by 0.9 trillion in the quarter and by 9.9 trillion in one year. This increase is mainly due to government and financial sector debt, while that of households and non-financial companies has dropped slightly over the last two years.
With the outbreak of the Middle East conflict, the market began to discount possible higher energy cost scenarios and, therefore, more persistent inflation and higher interest rates (short and long) over a longer period. This will affect the debt servicing costs of both governments and the private sector, which will gradually impact on the pace of renewals. Hence the urgency to redirect inflation expectations and, therefore, the promises of a longer restrictive monetary policy.
Economic policy and real estate market
As far as economic policy goes, there are two main vectors to be considered. The first of these is the fight against inflation by central banks and the second relates to stimulus policies executed by governments in an effort to achieve the much-desired soft landing.
Inflation has trended downward in recent months, showing that the monetary policy course adopted by central banks is finally working as planned, reducing credit availability and tightening financing conditions.
Governments also have their stimulus policies in place, such as the Inflation Reduction Act in the United States and the Recovery and Resilience Fund and the RePowerEU in the eurozone. These aid and investment programs have been partially cushioning the credit contraction and sustaining activity. At this time, it seems that there is a balance between these two forces that, in the absence of a financial accident, indicate that it will succeed in avoiding recessions in both the United States and the eurozone, although not in Germany.
In the real estate market, there has been a reduction in the borrowing capacity of applicants and, therefore, also in the granting of credit. This is also being observed in the construction sector in several countries where activity is visibly contracting, with Germany being a case in point.
The transmission of monetary policy that has begun to gain traction has started being felt in new construction: Germany (-30%), France (-24%), the United States (-30% in residential construction and -7% in aggregate). Real estate prices could therefore see some adjustment in the coming months, although this market is very inelastic on the downtick and the effect instead translates into a reduction in transaction volume.
In the United States in particular, there is notable tension in the commercial real estate sector (offices and retail), with lower occupancy rates in offices aggravated by the trend toward remote working.
Financial/real estate tension in China
In China, economic growth is being sustained thanks to the performance of some industrial sectors, such as automobile production, a sector that has surpassed Germany and Japan in production volume. The central bank has also been relaxing monetary policy through different levers, with the aim of maintaining credit flow to the economy. At the end of October, the central government unexpectedly announced fiscal support totaling 1 trillion yuan (1 trillion RMB), which involves raising the deficit from 3.0% to 3.8% of GDP.
This fiscal support is aimed at, among other things, supporting some regional governments in a tensioned financial situation. There is also tension in the real estate market, with the well-known difficulties of large promoters, including Country Garden, which entered into default in October.
The vulnerabilities associated with climate change (increased frequency and severity of cyclones, hurricanes, flooding, among other phenomena) are mainly reflected in extreme weather events that affect food prices and material construction costs. Society will have to accelerate investment in the energy transition, but in the process, there is a risk of discontinuing access to energy at moderate prices, with the resulting impact on competitiveness, productivity and the level of economic activity.