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Global Weekly Commentary: Gauging geopolitical risks
Key points
Still worth watching
The market focus is on the restart and inflation - and less on geopolitical risks – yet it’s worth watching specific risks as flareups could catch investors off guard.
Market backdrop
Inflation expectations eased on lower oil and commodity prices. We expect volatile near-term data amid pent-up consumer demand and supply shortages.
Data watch
Data are expected to show the U.S. personal consumption expenditure (PCE) price index rose 2.8% in April, above the Federal Reserve’s inflation target.
Market attention to geopolitical risks has fallen to four-year lows, our refreshed Geopolitical risk dashboard shows. We believe this is justified, as investors appear more focused on the economic restart and inflation outlook and less concerned about geopolitics since the change in U.S. administration. Yet it’s worth watching specific risks as flareups can catch investors off guard when attention is low.
Chart of the week
BlackRock Geopolitical Risk Indicator - global
Forward-looking estimates may not come to pass. Source: BlackRock Investment Institute, May 2021. Notes: The BlackRock Geopolitical Risk Indicator (BGRI) tracks the relative frequency of brokerage reports (via Refinitiv) and financial news stories (Dow Jones News) associated with specific geopolitical risks. We adjust for whether the sentiment in the text of articles is positive or negative, and then assign a score. This score reflects the level of market attention to each risk versus a 5-year history. We use a shorter historical window for our COVID risk due to its limited age. We assign a heavier weight to brokerage reports than other media sources since we want to measure the market's attention to any particular risk, not the public’s.
Our dashboard gauges market attention to overall geopolitics and to each of our top-10 risks by tracking the relative frequency of brokerage reports and financial news stories associated with the risks through BlackRock Geopolitical Risk Indicators (BGRIs). The global BGRI score has been trending down in the past year because of fading attention to risks such as U.S.-China strategic competition, Covid-19 resurgence and Gulf tensions. It has hovered in negative territory this year, as the chart shows, meaning market attention to geopolitical risks is below the average of recent years. Overall, this indicates a significant reduction in concern about geopolitical risk since the change in U.S. administration. Our dashboard also provides BlackRock’s fundamental assessment of the likelihood of each risk materializing in the near term. We also introduce a new quantitative measure that seeks to gauge how similar the current market environment is to our estimate of market movement in the event the risk materialized.
We introduce four new risks in the dashboard: Covid-19 resurgence, Emerging market political crisis, Global technology decoupling and Climate policy gridlock. Market attention to Covid-19 resurgence appears low, but we assign medium likelihood to this risk; attention to Emerging market political crisis is relatively elevated, yet we see a low likelihood. We see a high likelihood that decoupling of the U.S. and Chinese tech sectors accelerates in scale and scope, despite the relatively low attention to the Global technology decoupling risk. The pace of global reshoring of technological supply chains has sped up, potentially increasing production costs. This supports our view that markets are underpricing medium-term inflation risks. The Biden administration is continuing its predecessor’s posture of intense rivalry with China, with a focus on critical technologies, and China has made tech self-reliance a top priority. We believe it’s key to invest in both these poles of global growth, as detailed in The role of Chinese assets. U.S.-China tensions over Taiwan have been rising. We do not see near-term risks of military showdown but believe there is a significant medium- and long-term threat.
Climate policy gridlock refers to the risk that developed economies fail to increase public investment and regulatory action to achieve their goals to reduce carbon emissions. Attention to this risk appears low, as reflected in our BGRI, in line with our assessment of a low likelihood. We believe avoiding climate-related damages will help drive growth and improve risk asset returns, and have included the effects of climate change – and a climate transition – in our long-term return assumptions.
In some cases our dashboard reveals a disconnect between market attention and our fundamental analysis. Two examples: First, attention to Major cyberattack(s) risk has receded from a 2020 peak yet we see a high likelihood of this risk occurring. The recent hacking of a U.S. oil pipeline – and its impact on energy markets – highlights the risk. Second, market attention to a potential North Korea conflict is well below the historical average, but we rate the likelihood of the risk as “medium” – and see tensions as likely to increase heading into 2022. North Korean provocations, including long-range missile tests and potential for a nuclear test, could trigger a possible escalation.
The bottom line: We see a relative decrease in market attention to geopolitical risks as justified, particularly in light of powerful key near-term market drivers such as the economic restart and inflation outlook. We remain pro-risk, but note that geopolitical risk flareups could have an outsize impact when markets least expect it.
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