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Citigroup: There's a Whole New Type of Political Risk to Worry About

And it could compound traditional geopolitical struggles.

Investors have to acknowledge a new set of risks tied to socioeconomic concerns that go far beyond the realm of traditional geopolitical hazards and have the potential to roil economic activity and financial markets. The confluence of new and old political risks threatens to undermine progress made through globalization and foster a rise in conflict between, as well as within, nations.

That's the ominous conclusion of Citi's team of analysts, which includes Tina Fordham, chief global political analyst, Mark Schofield, managing director of global strategy, and Edward Morse, global head of commodities research. They joined forces with Jan Techau, director of the Carnegie Europe think tank, to create a report on global political risk.

Such traditional geopolitical risks as armed conflict and newer socioeconomic risks like income inequality, which Citi calls "Vox Populi risks," threaten to intersect "in an environment where global growth is stagnating while public expectations remain high and government capacity to effect positive change through reforms is low," wrote Fordham and Techau.

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Citigroup

Case in point, according to the pair, is the situation in Syria. An armed conflict has evolved into a sequence that could end up affecting politics throughout Europe following the settlement of millions of refugees.

Thus far in 2016, however, traditional geopolitical tensions—notably, between Saudi Arabia and Iran—have not translated into meaningful financial market shocks.

Accommodative monetary policy has kept financial markets from reflecting the brunt of geopolitical tensions, Schofield claimed. The stimulus deployed by the Federal Reserve and other central banks in the wake of the financial crisis had the effect of, among other things, putting downward pressure on risk premiums. The danger is that the Fed is beginning to withdraw this accommodation at the same time political worries mount, which could amplify any declines in risk appetite.

"There is an increasing likelihood that new transmission mechanisms are evolving that could lead to political risk having an impact on economic forecasting models, changing the way that companies do business and driving a secular, or even structural, increase in risk premia in financial markets," asserts Schofield. "Political risk can quickly and meaningfully alter return expectations across asset markets where transmission mechanisms are established in economic channels."

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Citigroup

Globalization has connected economies just as it has opened up avenues for political strife to destabilize this activity.

The erosion of the U.S.'s global standing and the relative toothlessness of international institutions has resulted in "Great Power Sclerosis," according to Citi, which has made preventing and resolving regional and local conflicts more difficult. To  compound concerns, large-scale governance uncertainty is not the sole domain of emerging markets, as demonstrated by government shutdown and frequent debt ceiling debates in the U.S. and by the rise in fringe, populist, and sometimes separatist parties in European Union member states.

Political events could affect commodity prices, while sanctions, stemming from the failure of diplomacy to bridge socioeconomic chasms, could damage select economies' outlooks while brightening those of others.

"Overall, however, a combination of more sanctions and increased protectionism is likely to result in lower levels of trade and this, with reduced comparative advantages in production, is likely to weigh on global growth and commerce," concluded Schofield.

The four "hotspots" in which Citigroup sees traditional geopolitical and new socioeconomic risks converging and evolving are: a return of the euro crisis, continued turmoil in the Middle East, friction between Asian behemoths, and fallout from the new oil order.

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