The risks that could push our debt-riddled economy over the edge

Overall, economic data from America, Europe and China are weakening. Consumer and producer confidence is fairly low in many places. 

Bank of America CEO Brian Moynihan sees that, compared to last year, consumers are significantly less enthusiastic about spending money. At the same time, Moynihan — whose bank has around 69 million customers — was relatively optimistic and does not see the U.S. entering a recession this year.

This was initially his economists’ expectations. But earlier this month investors were quite jittery. Stock markets worldwide took a big hit, Japan’s in particular. These losses have since almost or completely been recovered. Is this justified, or is a sharp deterioration in the economic climate looming?

Political issues are among the main threats the economy. Trade restrictions, sanctions and geopolitical conflicts can give an already fragile, debt-overladen global economy a push over the edge.

Political uncertainty will be very high over the next few months. First of all, the U.S. election is incredibly exciting. Kamala Harris may currently be a couple of percentage points ahead of Donald Trump in the polls, but due to the nature of the electoral system, the latter could still clinch the presidency with 47 percent of the national vote.

A second major political uncertainty is the turmoil in the Middle East. Iran is still expected to strike back in retaliation for the elimination of Hamas and Hezbollah leaders in Tehran and Beirut.

It is widely believed that Iran wants the retaliation to be substantial but doesn’t want to provoke a reaaction such as a military strike by Israel against Iranian nuclear facilities. Israel, in turn, is stuck with a leader who seems to have no intention of bringing stability to the region. 

For now, financial markets have been fairly unfazed, particularly in the form of oil price formation, by the conflict. However, all this will change when Israel and Iran clash more directly amid growing doubts about oil supplies from and shipping routes in the region.

A third threat is the Ukraine war. This risk is a sense similar to the risk from the Middle East in that the war has not moved the markets for quite some time. This may change with Ukraine’s bold incursion into Russia’s Kursk region; the natural gas market has already shown some movement. 

Vladimir Putin cannot stand by and let this go unchallenged, and so further intensification of the war is quite possible. Should Ukraine hold out on Russian territory for a considerable length of time, this will greatly undermine Putin’s position. In the most extreme case, he will be toppled. However, this would not necessarily turn out positively for the Ukraine and the West, as an even worse hardliner could replace him.

The political ground for the global economy and financial markets will not become any more fertile with the broader uncertainty about politics in Europe and the U.S., tensions between the China-Russia-Iran-North Korea axis and the Western bloc as well as the three aforementioned challenges. More volatility seems inevitable.

This is why assets considered to be safe havens seem like wise investment choices, with gold being one of them. This potentially also applies to commodities, but they run the risk that upward pressure resulting from safe-haven capital flows will be offset by downward pressure due to a weakening global economy.

From a political perspective, in a sense, what applies to commodities also applies to the dollar: The greenback usually offers investors a safe haven in times of uncertainty. 

However, the question is whether the dollar will remain this haven when uncertainty largely originates from the U.S. Worries stem from, for example, sharply deteriorating U.S. public finances and the selling of dollar reserves by authoritarian states — including China — that fear the confiscation or blocking of their dollars.

Finally, we should talk about the impact of politics on interest rates. Shorter-term interest rates in the U.S. and Europe may come under further downward pressure in the short to medium term as political developments depress global growth expectations and because central banks are inclined towards rate cuts. 

However, U.S. long-term interest rates, in particular, will likely have less downside potential, because non-Western countries probably want to continue the diversification of their reserves, and therefore, want to hold fewer U.S. government bonds. Also, inflation will come under upward pressure over time due to runaway public finances, protectionism and renewed disruptions of supply lines. 

This also means that the inverted yield curve may be pushed more toward a “normal” level: Recently, the U.S. yield curve briefly turned positive for the first time since July 2022.

Andy Langenkamp is a senior strategic analyst at ECR Research and ICC Consultants.