When we step back and assess the main sources of geopolitical risk to the global economy for the quarter, it's a mixed bag. Trade frictions will be high on multiple fronts, but they are unlikely to spiral into a trade war. There will be dramatic episodes in the U.S.-North Korea negotiation, but the risk of a military scenario will be low. Iran's risk to oil markets is largely known and underway. The election of a Euroskeptic government in Italy is driving up financial risk in Southern Europe. A confluence of macroeconomic factors is at the same time creating a perfect economic storm over several spots on the map.
The U.S. Federal Reserve appears to be on course for further monetary tightening this year, while other major central banks are proceeding with caution, creating upward pressure on the dollar. Combined with higher oil prices, the dollar's rise will compound pressure on countries that have large energy needs. The pain will be more acute for those countries with high amounts of dollar-denominated debt that are more vulnerable to swift capital outflows when spooked investors take cover under safer assets. The resulting currency pressures will stoke inflation and aggravate political problems in many countries, including Turkey, Argentina, Brazil, Colombia, Mexico, South Africa, India and Venezuela.
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