Connecting Markets East & West Global Markets Research P liti and Politics d markets: k t A changing h i context t t ‘Issues which keep me awake at night’ Interim update Alastair Newton – Senior Political Analyst, NIplc +44 20 7102 3940 [email protected] See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts. 4 November 2014 Any authors named on this report are research analysts unless otherwise indicated. Foreword This presentation offers a look ahead to what I currently see as the key political issues through to the year year-end end and into 2015. 2015 The calendar of political events again includes an initial list of important known political events in 2015. p Changes from the 9 October update are in italics for ease of reference. The order of the ‘issues’ reflects my subjective judgment of the current importance of each to market participants; and the number in brackets the ranking of each issue as of 9 October. 1 Key judgments The BoJ’s surprise move on 31 October (ie, as tapering comes to an end) has underlined my long-held view that monetary policy moves, moves not politics, politics stand to continue to be the main driver of market sentiment (page 15). However, it was also consistent with my opinion that the monetary context is b becoming i less l predictable di t bl than th has h been b th case so far the f this thi year – which hi h may increase risk aversion and, therefore, the likelihood of politics-inspired volatility. In this new monetary y context,, markets would therefore do well to continue to follow political developments closely, especially, in my opinion: – Possible threats to oil, including IS and the Iran nuclear talks (Issue #1); – Russia/West R i /W t relations, l ti nott only l over Ukraine Uk i but b t more widely id l (Issue (I #2) #2); – Surging nationalist sentiment in Europe, including Catalonia (Issues #3) and the United Kingdom (Issue #5); – Although currently quiescent, border disputes in Asia which could flare up again at any time (Issue #7), including between India and Pakistan (page 16); – The threat of the growing global phenomenon of serious civil unrest spreading to yet more economies (Issue #8). 2 1. MENA: More turmoil and oil (1) Relative even to six months ago, there are many aspects of the recently-declared US ‘war’ on Islamic State ((IS)) which are surprising p g (p (page g 5). ) But, from a market perspective, arguably the most significant of these is that Brent crude (pushed to USD 115pb in mid-June by events in Iraq) is currently languishing close to USD 86pb. 86pb * Acknowledging that this has much to do with supply-side factors, I also see it as a reflection of the minimal threat presently posed by IS to current oil output. But IS’s strength on the ground and unpredictability mean that this will not necessarily remain the case. This said, said for now I continue to see negotiations with Iran over its nuclear programme, due to be concluded by 24 November, as the most important potential political driver of the oil price in the near term. Furthermore, F th political liti l factors f t could ld see the th recentt four-fold f f ld uptick ti k in i Libya’s Lib ’ oilil output wiped out again. Thus, I do not expect p any y cuts in output p to be agreed g at the 27 November OPEC meeting. ________________________________________ * See: ‘Oil and politics’, Nomura Global markets Research, 20 October 2014. 3 1 (cont). MENA: Iran – Going to the wire (1) The 24 November deadline for reaching agreement with Iran over its nuclear programme p g is fast approaching, pp g with the outcome uncertain.* Although some are talking of a further extension in the absence of agreement, I think 24 November is probably a ‘hard’ deadline in practice. If the negotiations fail, fail I expect markets to look for a significant additional political risk premium on the price of Brent, driven by (misplaced, in my view) concern of a possible Israeli military strike against Iran’s nuclear programme in 2015Q1. However, I put a higher than consensus 50% likelihood on agreement being reached by the deadline, albeit with an associated risk of subsequent rejection by hardliners in Tehran and/or Washington: g – For Iran, fixing the economy requires relief from sanctions where failure to do so would, in my view, put the regime at risk of a major civil uprising;** – For the US, US a deal offers the longer-term longer term prospect of rapprochement with ith Tehran at a time when Sunni extremism appears to be the greatest threat to regional stability. _______________________________ * See: ‘Oil: The Iran “time bomb”’, Nomura Global Markets Research, 30 October 2014. ** See, eg: ‘Special Report: The revolution is over’, The Economist, 1 November 2014. 4 1 (cont). MENA: Islamic State (1) A recent article by the FT’s David Gardner offered what I see as a compelling assessment of how Islamic State (IS) threatens stability not only in Iraq and Syria but across the wider region (including, potentially, Saudi Arabia).* It follows, in my view, that although IS appears to be having no impact on the price of oil currently c rrentl – in contrast to mid-June mid J ne when hen its actions in Iraq drove dro e Brent to USD 115pb – it could yet do so again.** I see IS as a momentum-dependent organisation, ie, it needs to keep scoring ‘successes’ for its sophisticated PR machine to promote in order to attract a steady stream of recruits to its cause as well as less direct support. I therefore expect it to continue to use its military capability in ways which are likely to generate favourable (from IS’s perspective) publicity – and surprise. In addition to its probing in (predominantly) Muslim countries in the region, I th f therefore wonder d if IS might i ht launch l h some sortt off strike t ik (missiles?) ( i il ?) into i t Israel, I l nott least with an eye to trying to fracture the US-led coalition if/when Israel retaliates. ______________________________________ * Isis shows political sophistication as ferocious as its fighters fighters’ by David Gardner, Gardner Financial Times, Times 28 October 2014. 2014 ‘Isis ** See: ‘Iraq: A failing state?’, Nomura Global Markets Research,12 June 2014. 5 2. Russia/Ukraine: Bearing up (2) The recent relative calm on the ground (and the recent gas agreement between Kiev and Moscow) has allowed markets to relax a little over the Ukraine crisis, with ith (seemingly) (seemingl ) only onl a low lo likelihood currently c rrentl of additional sanctions.* sanctions * However, especially as Russia’s economy continues to languish and with “antiAmericanism…a pillar of the Kremlin’s ideology”, I see reasons for a continuing watchful eye as follows:** – A new staunchly pro-Western government in Kiev is likely to exacerbate existing tensions with Moscow which may yet cut off gas supplies; supplies;*** – Escalating Russian air incursions in the Baltic region in particular risk a mishap of some sort as Nato fighters scramble to intercept;**** – Russia appears to be willing to pressure the Baltic Republics in other ways too, with Latvia, taking over the EU presidency on 1 January, a possible focus; – Post Post-midterms midterms (Issue #10), we may see Washington taking a tougher line with Moscow, including fresh sanctions.***** ________________________________________________________ * See: ‘Ukraine and Russia: bound by gas, again’ by Dmitri Petrov and Peter Attard Montalto, Nomura Global Markets Research, 31 October 2014. ** ‘H d talk’, ‘Hard lk’ The Th Economist, E i 1 November N b 2014. 2014 *** See: ‘Ukraine: The Rada reloaded’ by Dmitri Petrov and Peter Attard Montalto, Nomura Global Markets Research, 28 October 2014 **** See, eg: ‘Baltic security: Tensions on the frontier’ by Richard Milne and Neil Buckley, Financial Times, 20 October 2014. *****See, eg: ‘Republicans seek a chance to govern’ by Barney Jopson et al, Financial Times, 3 November 2014. 6 3. Spain: Still a threat to eurozone stability (3) I remain minded that a single eurozone ‘issue’ unsettling markets remains unlikely. However, concurrent events may be more of a problem. But I see three possible events in 2015Q1 which, jointly, could rattle markets, ie: – An ECJ ruling against the ECB’s OMT programme (Issue #4); – Early E l elections l ti i Greece, in G with ith the th prospectt off a Syriza S i victory;* i t * and, d – A constitutional crisis in Spain over Catalonia’s independence drive.** The latter is, in my view, especially worrisome, with Catalonia seemingly set to hold a ‘consultation’ (a non-binding referendum in all but name, in my view) on 9 November, likely to be followed quickly by a regional election/independence vote. As the Financial Times recently noted: “Fears Fears that Spain may be heading for a period of political instability have yet to resonate with investors”.*** Furthermore, with fiscal transfers at the heart of the dispute between Barcelona and Madrid, the bond market appears vulnerable in the event of a political crisis – with the possibility that Spain could yet be forced to seek a bailout/bail-in. ________________________________________________ * See: ‘Greece: Taking stock ahead of a critical review’ by Dimitris Drakopoulos and Lefteris Framakis, Nomura Global Markets Research, 17 September 2014. ** See: ‘On the horizon #5: Catalonia – Breaking the bond?’, Nomura Global Markets Research, 19 December 2013. ***‘Crisis of trust as economic downturn in Spain ends’ by Tobias Buck, Financial Times, 23 June 2014. 7 4. Eurozone: ‘Central bank power’? (4) Following the BoJ’s 31 October move, my colleague Jens Nordvig wrote of ‘central central bank power power’,, underlining that “the the ball is now in the ECB ECB’s s court court”.* . Accepting this thesis, I nevertheless keep in mind that the ECB could yet find one of its ‘power-plays’, ie, Outright Monetary Transactions (OMT), neutralised by the European Court of Justice (ECJ) following the 14 October hearing on its legality. legality The ECJ’s ruling could, in my view, go either way – and will not be the last word, in any case – ie, with at least a possibility of a ruling against in whole or part. In this case, the ECJ’s ruling could also have implications for the deployment of other non-conventional measures by the ECB, notably quantitative easing. On the other hand, hand ECJ support of OMT would, would in my view, view fuel further sympathy for the AfD in Germany following its strong showing in three Länder elections this month with the Hamburg election in February offering an early test.* Nevertheless, with Berlin and Paris likely to remain at loggerheads and treaty amendments off the agenda until at least 2018, the ECB – and not central governments – remains, in my view, pivotal to eurozone prospects. ________________________________________ * See: ‘On central bank power: Lessons from the BoJ’ by Jens Nordvig, Nomura Global Markets Research, 31 October 2014. ** See: ‘Germany: Teutonic shifts’, Nomura Global Markets Research, 26 September 2014. 8 5. United Kingdom: All eyes now on the election (6) The UK Independence Party (UKIP) is on track to win its second Westminster seat from the Conservatives at a by-election y to be held on 20 November. However, in terms of the 7 May 2015 general election, I continue to think that the bigger story revolves around the Labour Party’s loss of support to UKIP.* Furthermore, F th a couple l off recentt opinion i i polls ll suggestt that th t the th Scottish S tti h National N ti l Party (SNP) is likely to win a large number of seats currently held by Labour. With opinion p polls continuing p g to p point to another hung gp parliament, this adds up, p in my view, to a non-negligible likelihood of the Conservatives, rather than Labour, securing a plurality – and a possible Conservative/UKIP ruling coalition.** This, This in turn, turn could reinforce pressure on Labour Party leader Ed Miliband to commit his party to a post-election EU ‘in/out’ referendum should Labour lead the next UK government. Although Alth h opinion i i polls ll have h recently tl been b suggesting ti that th t Britons B it would ld vote t to t stay in the EU, increasing tensions between Westminster and Brussels are making securing an ‘in’ vote look more and more of a challenge. _____________________ * See: ‘On the horizon #9: UK general election (2)’, Nomura Global Markets Research, 25 September 2014. ** See: ‘On the horizon #10: UK – The Brexit’, Nomura Global Markets Research, 24 October 2014. 9 6. China: Xi Jinping’s reform agenda (-) My 22 August report concluded that Xi Jinping, modelling himself on Deng Xiaoping, p g, would continue to p pursue an ambitious economic and social reform agenda, as well as his anti-corruption drive.* However, I suggested that his ‘political’ reform agenda would focus on what might better be termed bureaucratic/institutional reform and the rule of law. law The outcome of last month’s fourth plenum is, in my view, consistent with this – with, I believe, implementation of its conclusions a key factor in underpinning social stability (Issue #8; and also page 15, Hong Kong).** This is, I believe, especially so if GDP growth slows in 2015 consistent with our forecast. forecast.*** Nevertheless, I continue to take the view that social tensions in China will persist and that these could, in turn, encourage Beijing periodically to beat the nationalist drum as a distraction, distraction with Japan the obvious target (Issue #7).**** #7) **** ______________________________________ * ‘Tigers, flies and the elephant in the room’, Nomura Global Markets Research, 22 August 2014. ** See: ‘China: A blueprint for the rule of law’ by Chang Chin Hua et al, Nomura Global Markets Research, 29 October 2014. *** See: ‘Global Economic Outlook Monthly’, Nomura Global Markets Research, 14 October 2014, page 7. **** See: ‘2014 – East Asia’s 1914?’, Nomura Global Markets Research, 29 May 2014. 10 7. Maritime borders: 2014 – Asia’s 1914? (7)* Although China has reached a settlement with neighbouring states – except India – on a number of disputed p land borders,, Beijing j g continues to dispute p maritime borders with several neighbours, notably: – Although tensions with Japan generally appear to have eased somewhat for now I expect further flare-ups now, flare ups amid poor bilateral relations; – The withdrawal of a Chinese drilling rig from disputed waters around the Paracels may prove to be no more than a lull in tensions with Vietnam, especially now that the US has partly lifted its arms sales embargo; – China/Philippines tensions remain high, exacerbated by Manila’s recourse to UN dispute settlement and, likely, by the recent signing of a new Philippines/US defense agreement. President Barack Obama’s late-April visit to the region may have offered some reassurance to US allies relative to his cancelled October 2013 visit, visit but it does not appear to have discouraged China from pushing the envelope. ______________________________________ * See: ‘2014 2014 – East Asia Asia’s s 1914? 1914?’, Nomura Global Markets Research, Research 29 May 2014. 2014 11 8. Civil unrest: Going global (8) The past fortnight has seen two more outbreaks of significant civil unrest – in Burkina Faso (regime-ousting) and Hungary (policy-changing) – which have shown characteristics similar to the previous 14 or so since May 2014. 2014 * Although not hugely significant to markets, I find the Burkina Faso case particularly interesting in two respects, ie: – The economy has been struggling even more than usual recently thanks to falling commodity prices (cotton, in this case) which is a widespread issue (see, eg, Venezuela, e e ue a, page 16);** 6); – The proximate cause was the president’s attempt to do away with term limits, which may arise in the foreseeable future in countries of more significance to markets eg, markets, eg Democratic Republic of Congo. Congo Overall, I expect serious civil unrest to continue to break out globally, periodically – and often unpredictably – especially in economies which have: – A relatively high level of economic inequality and perceived corruption; and, – A young, well-educated and ‘middle-classed’ urban population joined up by social networks and disillusioned with their political leaders. leaders _____________________________ * See: ‘Civil unrest: Unrest for all seasons’, Nomura Global Markets Research, 24 December 2013. ** See: ‘The impact of commodity prices on EM’ by Rob Subbaraman et al, Nomura Global Markets Research, 28 October 2014 12 9. United States: More ‘trench warfare’ ahead (10) Recent polls have tilted back in favour of a narrow Republican Senate majority as a result of the 4 November midterms, ie, a net gain of seven seats which would give them 52/100. 52/100 The Republicans should retain solid control of the House. However,, ppersonally, y, I doubt that the outcome will matter much to markets one way or the other immediately, at least at the ‘macro’ level, despite other upcoming ‘issues’ on the Hill, ie: – The 30 September expiry of the current budget resolution; – The possibility of another debt ceiling-related impasse in 2Q15.* Especially with (but, likely, even without) a Senate majority, I expect the Republicans to look to use these issues to try to rein in the Administration on the environment and healthcare in particular – and, possibly, on immigration reform. This promises to precipitate another period of ‘trench trench warfare warfare’ in Washington over spending and budgets, which could yet command markets’ attention. That said, a Republican-controlled Senate may give the president Trade P Promotion ti A th it (TPA), Authority (TPA) facilitating f ilit ti progress on the th proposed d Transatlantic T tl ti trade and investment agreement (TTIP) and the Trans-Pacific Partnership (TPP). 13 10. North Korea: Who really holds the reins? (9) The recent re-emergence of Kim Jong un into the public eye has quelled much of the open speculation over North Korea; but questions still remain unanswered. unanswered I have long had doubts about the ability of as young a man as Kim Jong un to command firm control of what is still, in many ways, a Confucian society. However, on the other side of the scales, there is also the issue of the extent to which the regime depends on a cult of personality built around the Kim family – with no obvious replacement for Kim Jong un. While I find it plausible that he was suffering ill-health, this does not therefore preclude the possibility that, in reality, he is something of a figurehead with real power in the hands of the Organisation & Guidance Department. Department This would, I believe, be consistent with the recent visit of Hwang Pyong so, Kim Yang gon and Choe Ryong hae to Incheon for ‘secret’ talks. Nevertheless, whoever is in control, I do not expect fresh talks between the two Koreas to yield any substantive or lasting easing of tensions. _________________________________________ * See: ‘Korean peninsula: A snapshot from Seoul’, Nomura Global Markets Research, 10 April 2014. 14 Six of the rest (in alphabetical order) Argentina: As Argentina continues its battle with hold-out creditors, President Cristina Fernández does not appear pp to have a credible strategy gy for dealing g with the countries deepening economic crisis, raising the risk of renewed – and more serious – outbreaks of civil unrest. Hong Kong: As smaller scale protests (largely in Admiralty) continue, continue talks on “legal implementations of…political reforms” between pro-democracy leaders and Hong Kong officials stutter. Some protestors have already expressed disappointment over the scope of the talks; so, so the risk remains, remains in my view, view of a re-escalation of the protests. Nevertheless, my base case – for now, at least – is that the prevailing relative calm is likely to persist. Japan: Recent action by the BoJ has, I believe strengthened prime minister Shinzo Abe’s hand at an important time as he looks to: (a) secure final approval of a further hike in consumption p tax next y year,, ((b)) have two nuclear p power p plants put back in operation again, and (c) persuade corporate Japan to repeat this year’s pay awards in 2015. He may also be helped with the ‘third arrow’ if, postmidterms the US Congress gives President Barack Obama Trade Promotion midterms, Authority, thereby facilitating progress with the TPP (Issue #10). 15 Six of the rest (cont) Pakistan: A recent terrorist attack on the India/Pakistan border has fuelled concern that organisations g such as Jamaat-ul-Ahrar are seeking g to heighten g tensions between the two neighbours as a means of diverting the army from operations against the Taliban in the Afghanistan/Pakistan border area. The ongoing drawdown of Nato troops from Afghanistan is only, in my view, likely to increase the domestic terrorism threat and the risk of another attack on India emanating from Pakistan Turkey: IS IS’ss assault on Kobani and Ankara Ankara’s s initial response has damaged prospects for a lasting end to Kurdish terrorism in Turkey (as well as prospects for the approval of constitutional reforms which were shelved last year). However, as yet, t I see no evidence id off serious i d damage t Ankara/Erbil to A k /E bil relations l ti which hi h could ld put at risk the economically important hydrocarbons deal struck last year. Venezuela: The recent sharpp dropp in the oil pprice has left markets concerned over Caracas’s ability to meet sovereign debt obligations (counter-balanced, to an extent at least, by Venezuela’s significant offshore holdings which could be seized as compensation). compensation) Furthermore, Furthermore cuts to domestic spending could see a resurgence in serious civil unrest. 16 Some important dates: Nov - Dec 2014 4 Nov: 6 Nov: 10-11 10 11 N Nov: 9 Nov: 15-16 Nov: 16 Nov: 16 Nov: 23 Nov: 24 Nov: 27 Nov: 29 Nov: 30 Nov: November: 1 Dec: 21 Dec: 28 Dec: End Dec: US - Midterm elections OPEC - Launch of annual World Oil Outlook APEC - 26th Summit S i (i (in B Beijing) iji ) Spain - Catalonia independence ‘consultation’ G20 - Summit ((in Brisbane,, Australia)) Lebanon - Legislature elections Romania - Presidential election (round two if needed) Tunisia - Presidential election (round ( one)) Iran - Final deadline for agreement on nuclear programme OPEC - 166th ‘Ordinary’ y meeting g ((in Vienna)) Taiwan - Municipal elections Uruguay - Presidential election (round two if needed) Lebanon - Legislature elections (prov) EU - New president of the European Council takes office Uzbekistan - Legislature g elections ((1st round)) Tunisia - Presidential election (round two if needed) Egypt - Legislature elections (latest date) 18 Some important dates: 1H2015 1 Jan: 1 Jan: January: 14 Feb: February: February: 1 March: 22 March: 31 March: 17-19 Apr: 7 May: 17 May: y 4-5 June: 13 June: Q2: EU - Latvia assumes the EU presidency (until 30 June) G20 - Turkeyy assumes the G20 p presidency y ((until 31 Dec)) Uzbekistan - Legislature elections (2nd round) Nigeria - Presidential and legislature elections G Germany - Hamburg state elections Greece - Presidential election (indirect) Estonia - Parliamentaryy elections ((latest date)) Uzbekistan - Presidential elections (latest date) Finland - Parliamentary elections (latest date) IMF/IBRD - Spring meeting UK - Parliamentary elections Poland - Presidential elections ((latest date)) G7 - Summit (in Germany) Turkey - Legislature elections United States - Current debt ceiling likely to be hit 19 Some important dates: 2H2015 July: J l July: 25 Sept: p 11 Oct: 19 Oct: October: O October: October: 7 Nov: 20 Dec: December: EU - L Luxembourg b assumes the h EU presidency id ((untilil 31 D Dec)) Mexico - Congressional midterm elections IMF/IBRD - Annual meeting g (in ( Lima)) ((date tbc)) Portugal - Parliamentary elections (latest date) Canada - Parliamentary elections Argentina - Presidential and legislature elections Poland - Parliamentary elections Switzerland - Federal assemblyy elections Myanmar - Parliamentary elections (latest date) Spain - Parliamentary elections Russia - Parliamentary elections 20 Appendix A-1 Any Authors named on this report are Research Analysts unless otherwise indicated Analyst Certification I, Alastair Newton, hereby certify (1) that the views expressed in this Research report accurately reflect my personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of my compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company. 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