Eric Vandenbroeck 17 June 2018:

While South Korea and the United States are expected to announce the suspension of "large-scale" military drills this week, with the provision that they would restart if North Korea failed to keep its promise to denuclearize, news agency Yonhap said on Sunday. The world is muddling through a blurry transition from the post-Cold War world to an emerging era of great power competition.

Moscow Tries to Break a Stalemate with Washington. Poland and other borderland states will make appeals for stronger security guarantees from Washington while they still have the United States' attention. Russia will try to break a negotiating stalemate with the United States to talk sanctions, military build-ups and arms control by promoting its mediation in the Syrian conflict and its potential utility in North Korean denuclearization. Don't hold your breath for a breakthrough, though.

In harnessing the power of tariffs and extraterritoriality in sanctions, the United States will polarize many of its security allies in Europe and Asia - strategic partners that Washington needs to counterbalance the emerging threat from China and Russia. Attempts to target Russia's strategic relationships will call into question the long-term reliability of the United States as a defense partner and invite heavy pushback from Turkey, Vietnam, Germany and India, in particular.

As the limits of EU economic safeguards are exposed, Tehran will cautiously walk back its commitments to the nuclear deal while seeking out willing partners to circumvent sanctions. Russia will take advantage of Iran's rising vulnerability to deepen its military ties with Tehran while mediating between Iran and Israel in Syria. Turkey will be a big feature of the third quarter following a precarious electoral gamble by Turkish President Recep Tayyip Erdogan. Erdogan has the tools to eke out a win and whip up a nationalist reaction to any outside questioning of the vote, but the highly polarized country will remain on shaky economic ground amid worsening relations with the West.

Mexico's populist candidate stands a chance of winning big in July elections, which could pose a threat to energy and education reforms while further complicating NAFTA talks. A strong anti-establishment current will also be on display in Colombia, where the FARC peace deal is under threat, and in Brazil and Argentina, where the appetite for economic reform will plummet.

With several negotiations still pending - including discussions over the fate of the Korean Peninsula and high-stakes trade talks - a world weary from grappling with the fitful superpower is bracing itself for another quarter of whiplash from White House maneuvers.

But while Trump thrives on unpredictability as his chief negotiating tactic, many of his moves fit quite neatly - even predictably - in the context of the United States' great power rivalry with China and Russia. The United States' intensifying economic pressure on China, its harder-hitting sanctions on Russia and its growing support for critical borderland states, such as Taiwan, Ukraine and Poland, are all a part of this budding competition. Even the U.S. search for a way to reunify and denuclearize the Korean Peninsula is a piece of a broader long-term strategy to balance against China.

Yet the United States is creating bigger distractions for itself in the Middle East with Iran while putting stress on the very alliances it needs in its global competition with China and Russia. Although the contradictions in U.S. policy are taxing much of the world, this prolonged state of confusion is par for the course as the world muddles through a blurry transition from the post-Cold War world to an emerging era of great power competition.

 

For example U.S.-China Competition Builds

Narratives casting China as an economic imitator, as opposed to an innovator, are out of date. As the country grows more economically advanced, focusing its attention on game-changing technologies, the United States will heighten its economic scrutiny on China - and squeeze numerous companies along U.S.-Asian supply chains in the process. This dynamic will endure well beyond the quarter and the Trump presidency. In the name of national security, the executive and legislative branches of the U.S. government will continue to target the Made in China 2025 strategic development program through various means, including tariffs, sanctions and restrictions on investment and research. U.S. companies, particularly those involved in sensitive technology sectors, will face growing risk and uncertainty over the potential for export controls and for closer monitoring of foreign investments.

Specific measures to watch for in the third quarter include a special investment regime for Chinese companies designed to block investment into sensitive areas like robotics, telecommunications, semiconductors, artificial intelligence (AI), virtual and augmented reality, and new energy. The White House already has announced its intention to impose tariffs on up to $50 billion worth of Chinese industrial technology goods under a Section 301 investigation into Chinese intellectual property and technology theft. (More details are expected June 15.) The United States will apply tight scrutiny to outbound investment to or informal collaboration with Chinese companies, especially in high-tech sectors. Telecommunications firms Huawei and ZTE are already feeling the pressure; the U.S. Commerce Department has slapped hefty penalties on ZTE, while Huawei is under investigation by the Justice Department. In addition to those companies, the United States could expand its net to ensnare tech giants like Baidu, Alibaba and Tencent, launching investigations into web services they provide. Washington is also likely to impose visa restrictions on Chinese researchers and students in the United States.

And while there currently is a lot of talk about a major trade war, Washington and Beijing alike will eventually make concessions to justify dialing back their more extreme tariff threats. Still, the negotiations will be bumpy. There are hard limits to what each side can concede, and Chinese compliance is not assured, leaving the door open for some tariffs, and retaliatory measures, to shake out this quarter.

Internal White House dynamics will also be key to watch in tracking the progress (or lack thereof) in trade negotiations. Treasury Secretary Steven Mnuchin and White House economic adviser Larry Kudlow will push for a compromise that minimizes collateral damage, while economic adviser Peter Navarro and U.S. Trade Representative Robert Lighthizer drive a much harder, and perhaps impossible, bargain with China. In the lead-up to U.S. midterm elections, the White House will probably be more sensitive to retaliatory tariffs targeting the U.S. farm belt, where support for Trump was strong during the 2016 presidential race. Tariffs on smaller crops such as cranberries and ginseng, for example, could hit a political nerve in Wisconsin, a state in which the farming vote could make a big difference.

Even as the negotiation inches ahead, the United States won't prevent China from providing heavy, focused support to Made in China 2025 sectors. The U.S. pressure will only make China more determined to accelerate its drive to forge its own supply chains for sensitive technologies. China will, however, be willing to negotiate ways to increase U.S. imports, including of energy, semiconductors, vehicles and agricultural products; to partially liberalize certain sectors, such as the financial sector; to reduce some trade barriers for imported vehicles; to enhance intellectual property protection rights; and to restructure state-owned enterprises as part of its reform drive. Even if the United States hits it with tariffs this quarter, China has the political and economic means to withstand the blow at home. A growing number of maturing corporate bonds will add to the financial strain on local state-owned and private enterprises, but Beijing will inject liquidity selectively to ease the pain, particularly in central and northeastern China, and to manage any fallout.

 

A Framework for North Korean Denuclearization

Trump and North Korean leader Kim Jong Un will meet face-to-face June 12 for a much-anticipated summit in Singapore. While there will be moments throughout the process where it appears as if the whole dialogue is collapsing, there is reason to believe that the negotiation will still have legs by the end of the quarter. Our focus will not be so much on the drama to come, the typical walk-outs, name-calling and muscle-flexing - as Trump and Kim battle to prove who can play the unpredictability card most effectively in the talks. Setting aside the theater of the negotiation, the fundamental question for the quarter is whether both sides will muster enough political will to develop a framework for denuclearization. If a dialogue advances, it will likely start with freezing nuclear development, leaving room to tighten the screws on denuclearization over time. Just as the United States is unwilling to offer North Korea instant regime security, North Korea will negotiate denuclearization only over a long period of time.

Compared with previous efforts at negotiation, the stakes are much higher this time around. North Korea is closer than ever to its nuclear deterrent, and if the talks fail, the United States will have invalidated the diplomatic route. The United States would find it difficult to build international consensus to reinstate crippling sanctions on North Korea, much less a consensus to pursue a military option.

But a breakdown in talks with the United States would not necessarily lead North Korea to resume its nuclear testing immediately. Even if the United States walks away, China and South Korea would keep up the diplomatic momentum with North Korea, giving Pyongyang an opportunity to press its neighbors to ease up on their own economic sanctions.

Japan will remain largely on the sidelines of the negotiation, given its frosty ties with South Korea and even frostier ties with North Korea. As trade tensions mount between the United States and Japan over the threat of auto tariffs, Tokyo will do its best to keep them separate from its security partnership with the United States. Japan's biggest concerns lie in North Korea's short- and medium-range ballistic missile threats and any short-term shifts to the U.S. force presence on the Korean Peninsula that could also lead to a drawdown in Okinawa before it is politically and militarily ready to compete with China. Japanese Prime Minister Shinzo Abe will try to keep a high diplomatic profile this quarter both to try to insert Japan's security interests into the U.S.-North Korea dialogue and to distract his own constituency from a scandal that threatens his six-year tenure. Should Abe lose the critical contest for the ruling party's leadership in September, Japan could enter another period in which prime ministers come and go more frequently, creating more uncertainty as the great power competition in the Pacific heats up.

If the United States can manage to avoid a military conflict with North Korea, it will be able to apply more resources and attention to reinforcing countries in China's borderlands. Though China has managed to ease tensions with the states in its periphery, its continued militarization in the South China Sea will draw the United States into a more active military role in the region to balance it. The United States will increase naval deployments and patrols in the South and East China seas this quarter while working to expand military exercises with members of the Association of Southeast Asian Nations (ASEAN). An increase in U.S. deployments will lead to a period of heightened tension between Chinese and U.S. forces in these waters, and instances of harassment could become more frequent as the rate of close encounters and interceptions increases.

 

Friction Points in the U.S.-Russia Relationship

Russia's influence over North Korea will remain limited so long as Washington sustains its diplomatic engagement with Pyongyang through the quarter. If the talks make progress, Russia will try to secure a role in the denuclearization process to make sure it has a seat at the table. And should the talks collapse, Russia will align itself closely with China to resist the United States in the U.N. Security Council on sanctions and military action.

The push and pull between the U.S. Congress and the president on Russia policy can be messy and contradictory at times, but the result tends to be a harder U.S. line on the country. Congress will lean on the Treasury Department to sharpen its aim in targeting Russian elites with an eye toward sowing divisions in the Kremlin without creating the kind of significant global economic blowback that sanctions against Russian aluminum producer Rusal caused in the second quarter. At the same time, U.S. lawmakers will be working to implement the Russia-related provisions of the Countering America's Adversaries Through Sanctions Act (CAATSA) to coerce other countries to reduce their defense, intelligence and energy ties with Russia.

Though the White House has been more reluctant in the past to confront Moscow, secondary sanctions targeting Russia's defense and energy sales appeal to its business sense by creating more export opportunities for U.S. liquefied natural gas producers. They will also appeal to the United States' business sense by potentially creating more export opportunities for U.S. defense firms and for U.S. liquefied natural gas producers. Commercial interests, along with a growing U.S. strategic focus on Central and Eastern Europe in its competition with Russia and China, will give Poland, Ukraine and the Baltic states an opportunity to appeal to the White House for stronger security commitments. Warsaw, in particular, will try to advance talks with Washington over a permanent U.S. military presence in Poland, which will in turn cause Russia to up the pressure on Belarus to host a Russian airbase in its borders.

A potential military buildup in Russia's periphery is one of several factors that could prompt a high-level dialogue, or at least preparations for one, between Washington and Moscow this quarter. Russian President Vladimir Putin has a long list of items ready for when he sits down with Trump, including sanctions, military buildups and stymied arms control talks. Russia will try to use its mediation in the Syrian conflict and offers to help with North Korea's prospective denuclearization to present itself as a more constructive force. But the White House will engage with Moscow at a high level only if it feels that it has made enough progress on North Korea that it can deflect negative attention from the Russia-related investigations underway. Even if Trump and Putin manage to set up a meeting, the geopolitical environment will not be conducive to a grand bargain.

Having made it to a fourth term in office in elections in March, Putin will have to maneuver carefully among the government, his inner circle and Russia's powerful oligarchs as the United States dangles the threat of heavy sanctions over them. Efforts to consolidate the assets of Russia's elite will continue in the third quarter, as the Kremlin works to maintain economic stability and political loyalty. Higher oil prices will help ease some of the strain that honoring social pledges made during the campaign season, increasing security spending and hosting the World Cup have put on the Kremlin's finances. Competition among the security services remains a key area to watch as Putin balances among rival factions. We'll also be watching carefully for further signs that the longtime president is elevating younger members of the elite in search of a successor.

The more immediate priority in the quarter will be for Putin to try to take more steam out of opposition protests. In the second quarter, a wave of opposition protests in Armenia that swept longtime leader Serzh Sargsyan from power was another wake-up call for the Russian government and the heads of other former Soviet states: Once a protest movement has gathered enough momentum, not even brute force tactics can quell it. Determined to avoid a similar fate, the Kremlin will work on co-opting opposition leaders into government positions. Opposition leaders like Alexei Navalny are unlikely to fall for this strategy. But figures from other prominent dissident parties - especially those that stand to do well in September's regional elections, including Yabloko and the Communist Party - may yield to the Kremlin.

 

Doubling Down on Iran

A big element of the U.S.-Russia competition will also play out in the Middle East. In walking away from the Iran nuclear deal and reinstating hard-hitting sanctions, the White House is hoping against all odds to foment enough economic frustration in Iran to set regime change in motion. Israel, meanwhile, is seizing a rare opportunity to escalate its military campaign against Iranian and Hezbollah assets in Syria, knowing that it has firmer security guarantees from the United States to manage the fallout of a cycle of attacks and retaliatory attacks that risks drawing in Russia. Moscow will plan its next steps carefully with the aim of avoiding a direct collision with the United States while exploiting U.S. and Israeli needs to deconflict on the Syrian battlefield. Despite its attempts to mediate between Israel and Iran - in hopes of bargaining on a more strategic level with the United States - Russia's limited influence on the Syrian battlefield will prevent a lasting truce. Russia also will try to take advantage of Iran's vulnerability with the United States to deepen its own military footprint in the region. Watch for discussions between Iran and Russia over boosting Iranian air defenses and appeals from Moscow for access to Iranian bases.

Tehran's focus for the third quarter will be to buy itself as much room to maneuver as possible with those trading partners willing to risk U.S. secondary sanctions. In the immediate term, Iran will take care to avoid aggressive actions that could push the European position closer to that of the United States. But as the limits of the European Union's economic guarantees become more evident in the coming months, Iran's internal debate over how to proceed will intensify. Iran will probably still confine retaliatory attacks against Israeli strikes in Syria to the Golan and potentially the Palestinian territories as it tries to avoid a bigger conflagration. It will also test the limits of the nuclear deal and its cooperation with Europe, for instance by threatening to increase enrichment, to limit access to International Atomic Energy Agency inspectors or to withdraw from the Nuclear Non-Proliferation Treaty.

The European Union, for its part, has imposed regulations to block the application of U.S. secondary sanctions to European companies. In addition, it will consider such measures as compensating EU firms for their losses in Iran, increasing euro-denominated trade with Iran, offering new credit lines for companies doing business in the country and arranging currency swaps to bypass the U.S. financial system. Italy, France and Germany will be the most motivated to set up financial mechanisms to continue trade with Iran. Likewise, smaller Chinese and Russian firms with fewer connections to the U.S. financial system will be willing to maintain or even expand their economic ties with Iran. But most corporations with financial exposure to the United States will make the pragmatic choice to reduce or eliminate their ties to Iran to maintain access to the U.S. market. And even China will be wary of defying the United States because of the case involving ZTE, which Washington hit with a crippling punishment for flouting sanctions.

Growing economic strain will continue to depress the value of the Iranian rial and spur inflation, creating a groundswell of domestic discontent that could drive sporadic demonstrations. But Iran has already been preparing its economic insulation strategy. To muddle through, the Iranian government will emphasize domestic production and negotiate agreements and barter arrangements in nondollar trade. Tehran will also work on financial reform to comply with international banking regulations as part of a broader effort to cushion the blow of U.S. sanctions. Since the United Arab Emirates is on more hostile terms with Iran today than it was when the Islamic republic was last under crippling sanctions in 2012, Tehran will depend more this time on Qatar and Oman to re-create a web of financial and shipping methods to skirt the measures. Similarly, Turkish banks - now under much tighter U.S. scrutiny - probably won't be as reliable an option for circumventing sanctions this time around, though Turkey will maintain significant economic ties with Iran.

 

The Cost of Alienating Allies

The White House is stretching the limits of executive action in fighting multiple battles on the economic and foreign policy fronts. By harnessing the power of tariffs and extraterritoriality in sanctions, the White House will polarize many of the security allies it needs to counter an emerging threat from China and Russia.

Taiwan and South Korea, and to a lesser extent Japan and ASEAN, are the most exposed to major disruptions in the U.S.-China supply chain and are bracing themselves for blowback from the tariffs that may emerge from the U.S.-China economic standoff. The threat of auto tariffs this quarter will add strain to the United States' relationships with South Korea and Japan, though Seoul may have a better shot at negotiating exemptions as part of its talks to revise the United States-Korea Free Trade Agreement.

Europe, too, is caught in the middle of this broader competition. Costly tariffs and unilateral sanctions are stirring the Continent to reclaim its economic sovereignty from its long-standing Western partner across the Atlantic. The problem is that Europe is not a single nation with a unified voice. Germany, whose heavy dependence on exports gives it incentive to a find compromise with the United States, particularly as the threat of auto tariffs looms, will not be able to negotiate a comprehensive trade agreement among more skeptical EU member states to try to defuse trade tensions with Washington. Nevertheless, the European Union will consider more modest measures to appease the United States, such as eliminating reciprocal tariffs on industrial products (and lowering the EU tariff on cars), reducing regulatory barriers to trade and restricting exports or introducing import quotas.

France will lead the battle to maintain the European Union's relevance in the face of great power competition and growing U.S. unilateralism. Paris will work this quarter to strengthen Europe's strategic autonomy through defense cooperation pacts, including the Permanent Structured Cooperation (PESCO) and the European Intervention Initiative. In trying to ensure Europe is still in the global race to develop AI alongside the United States and China, France will try to spearhead a European strategy for the technology. Connected to this goal, the European Commission will work to deepen the digital single market by eliminating barriers to international e-commerce while protecting consumers. But fragmented markets and differing regulations among member states will slow progress to that end. The complications from EU fragmentation will be on display this quarter when the bloc starts implementing the General Data Privacy Regulation and could undermine AI development on the Continent in the long term.

France will also try to drive a discussion around reforming the World Trade Organization (WTO), another casualty of U.S. unilateralism. The United States has made a legally explosive national security argument under Section 232 of the Trade Expansion Act of 1962 to justify protectionist measures on imports of steel, aluminum and now automobiles and auto parts. While polarizing key allies in Europe and Asia, the Section 232 cases also put U.S. Gulf partner Qatar in the uncomfortable position of battling the United States in the WTO. Doha has cases against Saudi Arabia, the United Arab Emirates and Bahrain for waging an economic attack on it in the name of national security. Either way the case goes, the risks are high: If the WTO upholds the national security argument for trade protectionism, it will set a dangerous precedent, and if it shoots down the U.S. case, it will risk exacerbating its credibility crisis should the United States ignore the ruling altogether.

 

Managing Difficult Relationships

Europe, in turn, is trying to demonstrate its support for the United States in countering China's trade abuses, but not at the cost of wrecking the WTO's credibility. The approach of an EU-China non-Market Economy case and the precarious position of the WTO Appellate Body will prompt the European Union to push for a reform dialogue and mediate between the United States and China. But the United States won't be receptive to Europe's appeals this quarter while it's still on the economic warpath. Despite calls from Macron, a serious discussion on reforming the WTO that has any chance of keeping the United States engaged will have to come later.

A concerted push by the U.S. Congress to get CAATSA up and running will further complicate U.S. security relationships abroad. The legislation contains a secondary sanctions provision for states engaged in significant defense, intelligence and energy transactions with Russia. The U.S. executive branch will still be able to rely on a national security waiver to exempt more sensitive allies from punitive measures, but the legislation is designed to hold the White House accountable for other countries' efforts to steadily reduce their strategic ties with Russia in exchange for the waivers. Germany, Vietnam and Turkey are the states most likely to defy U.S. pressure on their Russia relations, while India is the most vulnerable and will struggle to find a balance between Moscow and Washington. The CAATSA drive could in some cases generate defense sales opportunities for foreign competitors if countries think the United States is too unreliable a defense partner.

 

A Turbulent few months for Europe

A Euroskeptic government has taken hold in the European Union's core: The new Italian government, led by Euroskeptic and nationalist parties the Five Star Movement and the League, will try to reverse austerity policies instituted by prior governments and increase spending. Specific measures include abolishing a controversial pension reform, lowering household taxes and increasing assistance for low-income families. Moving the proposals forward will be no small feat and will require the government to overcome internal divisions and institutional constraints. Even so, because of the expense - and the challenge to EU fiscal deficit rules — that the measures entail, EU institutions and the German government will be on guard. Italy will be ready to ignore EU deficit and debt rules in bargaining with Brussels, but it won't go so far as to make a unilateral move to pull out of the eurozone this quarter. And even though Italy isn't facing an imminent financial crisis, the country's defiance toward EU fiscal rules is still a threat to the currency area. After all, Italy will be looking for allies in Southern Europe, including France, Spain and Greece, to join its calls for increased spending at the continental level and more flexible EU fiscal rules.

Italy's closer ties with Russia will raise concerns in the European Union - and hope in Moscow - that Rome could keep the bloc from reaching the unanimous vote required to uphold EU sanctions on Russia. Italy could demand a review of the measures and greater justification for continuing them during the EU debate, but Rome is unlikely to take too strong a stand on Russian sanctions when it has a much bigger battle with Brussels looming over its economic agenda. A potential Italian rebellion is one of several factors driving an EU debate over how to escape the "unanimity trap." Watch for an important proposal from the European Commission this quarter that would streamline decision-making by allowing the bloc to make decisions on foreign policy issues by a majority vote. The change, if eventually adopted, could threaten states' national sovereignty on critical foreign policy matters.

While Italy spooks the eurozone, the German government, under pressure from both conservative lawmakers at home and from its allies in Northern Europe, such as the Netherlands, will try to shelve, postpone or water down reform proposals from France. We expect the two to reach agreement on issues such as the introduction of mechanisms to increase investment across the European Union, the introduction of a common backstop for eurozone banks or the creation of a European monetary fund. But they will probably postpone more controversial plans, such as the introduction of a common guarantee for deposits in eurozone banks, or at least link the proposals to measures to reduce financial risk in the region's banks.

France and Germany likely will abandon other suggestions, including the creation of a finance minister for the eurozone. The continued debate over the EU budget will add to the friction. Net contributors - most of which are in Northern Europe - will resist enlarging their national contributions to the budget, while net receivers of structural funds (mainly in Eastern Europe and, to a lesser extent, Southern Europe) will fight to keep their share. Proposed cuts to agricultural subsidies will rile up farm lobbies in France, Spain, Ireland and elsewhere. And states in Central and Eastern Europe will form a united front against Brussels' attempts to make the disbursement of EU funds contingent on respecting the rule of law.

Adding to the political risk in the eurozone, the Brexit process will become increasingly toxic this quarter. The British government will have to deal with an increasingly rebellious Parliament, where the idea of remaining in the customs union is gaining traction. The British government has until the EU summit in late October to try to patch up this divide while bargaining with Brussels over its two seemingly incompatible goals of leaving the customs union while maintaining an open border between Ireland and Northern Ireland. The longer London plays for time, though, the weaker and more divided the government will become - increasing the chances of Parliament taking control of the Brexit process and keeping the United Kingdom in the customs union.

 

Market Volatility in the Energy Sector

In anticipation of the return of U.S. sanctions on Iran's oil exports Nov. 4, many countries will work to reduce their oil imports from the country throughout the quarter. Along the way, they could create a gap in supply in global oil markets that threatens to drive up prices. The size of the gap will depend on how stringent the United States will be in granting sanctions waivers to countries that reduce their oil imports from Iran. Under former President Barack Obama's administration, countries could qualify for waivers after cutting their imports of Iranian oil by around 20 percent, but the Trump White House could raise the requirement. (Either way, the U.S. sanctions will gradually reduce Tehran's incentive to stay in the Iran nuclear deal since countries must keep lowering their imports to continue qualifying for the waivers.) The key White House negotiations to watch in the quarter will be with EU members - especially ltaly, Germany and France - China, South Korea and India. We can expect at least 400,000 barrels per day of Iranian oil to go offline by the end of the year.

Saudi Arabia and its Gulf Cooperation Council (GCC) allies Kuwait and the United Arab Emirates, as well as Russia, will keep an eye on the oil market this quarter in case they need to intervene. Along with the drop in Iranian oil exports, big production declines in Venezuela and Mexico will require Russia and the GCC states to work together to make up the shortfall. When the world's major oil producers meet in Vienna on June 22, they could agree to loosen oil production quotas while watching and waiting for the Iran developments to take their toll on the markets. The group of oil producers participating in the production cap has already met its goal of returning global oil inventories to five-year averages to restabilize the market. As a result, its members have more room to increase production as needed.

Saudi Arabia, however, will be cautious in planning a market intervention. Riyadh is aiming for a higher price band (possibly around $100 per barrel) in preparation for the initial public offering of its state-owned oil company, the Saudi Arabian Oil Co., and in a bid to reduce its budget deficit. But Saudi Arabia will have to weigh those economic considerations against its strategic partnership with the United States. The White House will be leaning on Riyadh to intervene in the oil market and prevent a big hike in gasoline prices ahead of U.S. midterm elections. The Saudi government may well acquiesce.

When we step back and assess the main sources of geopolitical risk to the global economy the next few months, 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.

 

Turkey

Turkey will hold presidential and parliamentary elections June 24, a year and a half ahead of schedule. Turkish President Recep Tayyip Erdogan has a lot riding on the vote after narrowly winning a referendum to enhance the powers of the presidency; if he wins, he could remain in the presidency until 2029. By holding the election so early, Erdogan is trying to head off both a nascent opposition coalition and an economic hailstorm pelting his voter base. Turkey's electorate is essentially split down the middle, and a diverse set of opposition parties are forming a coherent argument against Erdogan and his handling of the economy. An election that could yield narrow margins and end in a runoff raises the potential for vote rigging and public outcry, but Erdogan will have the benefit of power working in his favor.

The incumbent president can rely on the country's state of emergency to manage any fallout, all the while spinning any criticisms from Europe into nationalist propaganda. Turkey's hefty dollar-denominated debt, together with Erdogan's attempts to strong-arm the central bank to defy market pressure, will make this a particularly stressful quarter for the Turkish economy. On top of the country's political and economic woes, Turkey is facing stiff headwinds in its strained relationship with the United States as Washington tries to leverage secondary sanctions against Russia and Iran to constrain Ankara's relations with them.

 

Argentina

Argentina, under currency pressure from a rising dollar and a mountain of dollar-denominated debt, faces a story similar to Turkey's. But in Argentina, the political damage is likely already done: As the weak peso continues to feed stubbornly high inflation, it will further erode President Mauricio Macri's support base. What's more, under the conditions of a deal with the International Monetary Fund for credit lines, Macri's government will probably have to cut public spending, including transfers of funds to provincial governments. The cutback will cause opposition governors to pressure the national government for more money by pulling back congressional support for Macri's proposed legislation, such as labor reform. Coupled with Argentina's growing trade and current account deficits, voters' economic pain will push the next government toward greater protectionism. It will likely resist moves from the Common Market of the South, better known by its Spanish acronym, Mercosur, to explore additional trade agreements, though deals that are already well underway - such as the EU-Mercosur trade agreement - are safe. In time, Argentina will be out of step with other Mercosur members, such as Uruguay and Paraguay, on foreign trade.

 

Mexico

In Mexico, the strong U.S. dollar is already hitting the peso hard. Prolonged uncertainty over the North American Free Trade Agreement renegotiation and a potential populist victory in the presidential election this quarter threatens to create more economic turmoil. Mexico will hold elections for the presidency and for Congress on July 1. Among the presidential contenders, populist candidate Andres Manuel Lopez Obrador leads the pack. Lopez Obrador's political influence, should he become president, will depend on whether he controls a congressional majority. Much of his policy agenda, which includes a rollback of education reform, fuel price freezes and cuts to the federal budget, will be virtually impossible to implement without congressional consensus. Mexico's historically dominant parties, the Institutional Revolutionary Party (PRI) and the National Action Party (PAN), will form a tactical alliance in Congress to try to block Lopez Obrador. In the event that Lopez Obrador picks up a majority in both houses, PRI and PAN would have to rely on the courts to resist the president's more controversial policies.

At this point, the odds are looking slim that the United States will reach its goal of closing a NAFTA deal ahead of the Mexican elections. Canada, Mexico and the United States still have yet to agree on overall rules of origin requirement or on regional content quotas for individual automotive components. While Canada could adapt to the U.S. demand to shift a portion of vehicle production to higher-wage areas, Mexico, which relies on lower wages for competitiveness, would find it more difficult, if not impossible. And even if NAFTA's parties come to an agreement in time, the White House is likely to face resistance from the U.S. Congress if a deal lacks strong protections for investors and labor. Trump could try to break the stalemate by threatening a withdrawal from the agreement or by breaking the negotiation down to the bilateral level, but such extreme moves on NAFTA would likely galvanize Congress to take legislative action to prevent or nullify them.

 

Colombia

The Colombian peso has fared far better than its regional peers, but there are still lingering risks to the country's peace agreement with the Revolutionary Armed Forces of Colombia (FARC) that will bear close watching this quarter. A pending investigation into high-level FARC leaders by Colombian and U.S. authorities will complicate things for the next government if a centrist or leftist candidate comes to power in the June 17 runoff election. Depending on how far the investigations go, the peace deal with the FARC could falter and put oil companies and other businesses in northeastern and southwestern Colombia in danger of extortion or attack. Colombia's next president will also be more reluctant to sign new trade agreements as domestic industries come under greater pressure. Pending trade agreements, particularly those with Turkey and Japan, will be at risk unless their proposals for agricultural trade improve significantly for Colombia.

 

Brazil

As presidential campaigning picks up this quarter in Brazil for the October elections, the pace of economic reforms will slow. Higher fuel prices are inspiring protests and feeding a growing anti-establishment current in the country. In Congress, lawmakers won't have the appetite to approve controversial measures like pension reform. The traditional parties that back the current government, such as the Brazilian Democratic Movement, will try to seal an alliance with as many other parties as possible to try to fend off the anti-establishment threat coming from right-wing lawmaker Jair Bolsonaro, environmentalist Marina Silva and center-left nationalist Ciro Gomes.

 

India

For India, the world's third-largest oil consumer, rising oil prices and a strengthening dollar mean a wider trade deficit and investor outflows from the country's equity and debt markets. These global developments are happening as the ruling Bharatiya Janata Party is ready to fund populist measures to win votes ahead of the 2019 elections, suggesting that the fiscal consolidation drive in the world's fastest-growing major economy will slow through next year, while job creation stays sluggish.

India is walking a tightrope among China, Russia and the United States. Prime Minister Narendra Modi wants to avoid another politically costly standoff with China as he campaigns for a second term in office. With that in mind, he's embarking on a tactical recalibration with Beijing, suggesting the relationship between the two nuclear giants will return to a state of managed tension, even as each side quietly continues military and infrastructure buildups on the border. Facing the threat of U.S. sanctions for its economic ties to Iran and its defense ties to Russia, New Delhi will begrudgingly bargain for exemptions while balancing with Russia. The U.S.-India relationship will be strained as a result. The degree to which these irritants undermine the growing strategic defense partnership between the two countries will become more evident when their foreign and defense chiefs meet in July.

 

South Africa

As the 2019 elections draw closer, South African President Cyril Ramaphosa is trying to have it both ways: He needs to push a pro-business agenda to stimulate the economy while pursuing populist measures to shore up the African National Congress's electoral defenses. Ramaphosa will be focused mostly on winning over investors in the next quarter before the 2019 campaign season gets into full swing, though downward pressure on the rand threatens to ratchet populist pressures up. Steadily rising investor confidence is likely to extend to the mining industry as the new administration tries to streamline regulation and increase transparency through a new mining charter. Anti-graft efforts, moreover, will continue apace under Public Enterprises Minister Pravin Gordhan, who plans to target South Africa's state-owned enterprises, a hotbed of corruption.

 

Venezuela

Venezuela is too far gone for higher oil prices to alleviate its troubles this quarter. In fact, its cratering oil production - already down by 500,000 barrels per day this year, is a big factor behind the global shortfall. Production will fall further as inflation worsens, currency shortages at state oil company Petroleos de Venezuela become more acute and workers desert their posts. The Venezuelan government, meanwhile, will try to keep local transport ships from docking at oil terminals where creditors could seize the oil as payment for arbitration awards and disrupt the country's energy export activities. Along with possible U.S. sanctions on the energy sector, the threat of large-scale asset seizures - which would raise the risk of unrest or even a coup - will loom large in Venezuela this quarter.

 

 

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