Geopolitical Uncertainty Expected to Continue
Strategas Washington Policy Research
The US is facing a more multipolar world as Russia and China challenge the West.
When Russian President Vladimir Putin and Chinese President Xi Jinping stood together at the 2022 Winter Olympics and announced that they planned to challenge the world order, we noted that it marked a significant shift in our geopolitical framework. Russia invaded Ukraine less than three weeks later, and geopolitical tensions have only continued to rise since then.
Russia and China are trying to create a multipolar world that directly challenges the United States and its Western allies. We have seen the Biden administration accelerate its push to “de-risk” the US from China and encourage US allies to do the same. Ukraine remains locked in battle with Russia, with the US and Europe continuing to provide significant military aid to Ukraine. The US increased military aid to Israel following the October 7 attack and has been looking to support Taiwan’s ability to defend itself should China attempt to take control of the island. Unrest is growing in other parts of the world, as well; notably, there has been in uptick in sub-Saharan African countries experiencing coups in the past few years.
A risk for America is that if the US is preoccupied on too many fronts, it becomes easier for other countries to take advantage. China took control of Hong Kong while most of the world was fighting the COVID-19 pandemic—and China may look to move on Taiwan if the US is stretched thin with other geopolitical flashpoints.
A return to the period before the Berlin Wall fell.
This new geopolitical framework is heightening the focus on national security and supply chain resilience while muting economic efficiency as a priority. It is also leading to the need for greater investments in defense, both in the US and elsewhere. We expect this less globalized world to be characterized by slightly higher inflation, slightly higher interest rates, and lower price-to-earnings ratios on stocks—an environment we have not seen since the period before the Berlin Wall fell (which itself was an event that greatly accelerated globalization).
It is also important context that this is occurring as the US fiscal condition is constrained by higher net interest costs (a result of high inflation) and fewer natural buyers of US Treasury bonds. President Biden has presented Congress with a $106 billion supplemental budget request to provide aid to Israel, Ukraine, Taiwan, and the Indo-Pacific more broadly, and to secure the southern border with Mexico.
How the bond market reacts is key.
How the bond market responds to passage of the president’s budget request will have important implications for investors, as the package comes after US net interest costs have hit 14% of tax revenues, an inflection point at which we have historically seen the US economy move from fiscal accommodation to fiscal austerity.
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