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Geopolitics – Implications for the Economy & Markets

Article  •  April 17, 2024
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“Geopolitical risk” is a sweeping term that encompasses military confrontations, diplomatic standoffs, cyberattacks, sanctions programs and tariffs, with channels of transmission including global trade, supply chains, capital flows and financial markets – especially commodities markets. A new Must C report from a team led by Nathan Sheets considers the effects of recent geopolitical shocks, including the Russia-Ukraine war and the escalating conflict in the Middle East. We also discuss longer-term structural developments such as the rise of China and other BRICS nations and the increased prominence of populist political voices. And we consider how investors should navigate geopolitical complexities.

Over the last 50 years, commodities and commodity-producing countries and regions have generally played a central role in the onset and transmission of geopolitical shocks. A key question: How will the ongoing transition to renewables and decarbonization influence this dynamic? While it’s plausible that geopolitical pressures will become less frequent, it’s more likely that tensions will shift to other goods and services, such as advanced semiconductors, rare earth metals, copper or even the availability of data.

There’s a common perception that geopolitical shocks are becoming more frequent and severe, but a look at an index of geopolitical risk prepared by Fed researchers finds little support for that idea. Still, given the array of pressures in play, investors would be well-advised to prepare for the possibility that such pressures may become more intense. Another consideration is that national authorities look to have become more reliant on economic tools to achieve their political objectives – to note two examples, coordinated sanctions have been a prominent response to Russia’s invasion of Ukraine, and the U.S. has made heavy use of economic tools in dealing with China.

From a macroeconomic standpoint, we conclude that geopolitical challenges typically affect the economy as supply shocks and tend to result in slower growth and (at least through a transition period) higher inflation. Unfortunately, this presents central banks with a Hobson’s choice: tighten policy to fight higher inflation and so risk further weakening the economy, or ease policy to support economic activity and so risk still higher inflation.

Geopolitical challenges, in our view, have been a reality for generations and are likely to remain one. Investors would be wise to become well-versed about their dimensions and likely implications, taking care to neither underestimate nor overestimate their significance.

Our new Must C report, Geopolitics – Implications for the Economy & Markets, also looks at the differing effects of geopolitical pressures on developed-market and emerging-market economies and offers an empirical assessment of how markets respond to such shocks. Read the full report here.

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