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Geopolitical Risks
Exhibit 63: Non-Financial Corporate Sector Debt Service Ratio
The debt-servicing burden of corporations is at its lowest in over 40 years.
% of Income Debt Service Ratio
50 +50 bps Rate Shock +100 bps Rate Shock
40
30
33.4 Q4 2008
20
10 13.1 12.6 11.7
1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020 2024
Data through Q3 2021. Note: Shaded periods denote recessions. Source: Investment Strategy Group, Federal Reserve, Haver.
Exhibit 64: Household Sector Debt Service Ratio
Households’ debt service ratio would remain low even with higher rates.
% of Disposable Income Debt Service Ratio
15
14
13
12 +50 bps Rate Shock
12.8 Q4 2007 +100 bps Rate Shock
11
10
9
8
1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020 2024
Data through Q3 2021. Note: Shaded periods denote recessions. Source: Investment Strategy Group, Federal Reserve, Haver.
and corporations, lead to higher defaults and widen credit spreads. We believe that concern is misplaced. As shown in Exhibit 63, the debtservicing burden of non-financial corporates is at the lowest it has been in over 40 years. An increase of 50 basis points in 2022 would raise the ratio of net interest expense to earnings before interest and taxes from 11.7% to 12.6%. An additional 50 basis points would increase the debt service burden to 13.1%. Most of corporate debt is fixed and the weighted average maturity of that debt is over 10 years.
Exhibit 64 shows a similarly muted impact for households. The ratio for households is measured as the ratio of debt service payments for mortgages and consumer debt to disposable personal income. A 50-basis-point increase in interest rates raises the debt service ratio from 9.2% to 9.3%, and a 100-basis-point increase in rates raises the debt service ratio to 9.4%. None of these increases in the interest burden raises the likelihood of a recession.
Geopolitical Risks
We expect Russia and Iran to be the two most likely sources of geopolitical risks in 2022.
Russia: Former Secretary of Defense Ashton Carter, with whom we consult on geopolitical and international security issues, considers the Russia-Ukraine crisis “the most dangerous, dire and imminent of all the geopolitical risks.”22 Russia has amassed over 50 battalion tactical groups compared to eight such groups in 2014 when it seized Crimea, and it has positioned an estimated 100,000 troops near Ukraine.23
Russia has used the threat of an attack on Ukraine to make a series of demands, the most important of which are:
For Russia, the benefits of a military invasion of eastern Ukraine are limited, and the price of economic sanctions could be high.
• Legal guarantees not to deploy weapons on Russia’s western borders that are a threat to Russia. • NATO must refrain from allowing
Ukraine and Georgia to join the organization. • A “legally binding agreement”24 not to deploy strike weapon systems in
NATO and non-NATO countries adjacent to Russia (see map).
The most likely path forward in the near term is negotiations between the US and Russia. For Russia, the benefits of a military invasion of eastern Ukraine are limited, and the price of economic sanctions from the US and Europe, united in their stand against Russia, could be high. The probabilities of an invasion increase later in the year. Carter assigns a 50% probability and Signum Global assigns a 35% probability to the risk of a Russian invasion.
Iran: President Joe Biden’s special envoy for Iran, Rob Malley, said it best: Iran is “a cauldron always being one step or misstep away from a much more dangerous conflagration.”25
Iran poses two risks:
• A year after President Donald Trump abandoned the Joint Comprehensive Plan of Action (JCPOA), Iran abandoned various restrictions on its nuclear program: – It has installed faster and more efficient centrifuges for enriching uranium.26 – It has increased enrichment from the 3.67% level of enrichment agreed upon under the JCPOA to 60%, which has reduced breakout timelines for producing weaponsgrade uranium. The Institute for Science and
International Security estimates a worstcase scenario of three weeks to produce 25 kilograms of weapons-grade uranium, sufficient for a single bomb.27 – It has hindered the ability of the International
Atomic Energy Agency (IAEA) to monitor
Iran’s nuclear activities.28 • Iran has built an extensive missile program and has become one of the top missile producers in the world.29 According to Kenneth
“Frank” McKenzie Jr., Marine general and the commander of the US Central Command covering the Middle East and South Asia: Iran has reached “overmatch” where its “strategic capacity is now enormous,” and it has “the ability to overwhelm.” Its missiles “can strike effectively across the breadth and depth of the
Middle East … with accuracy and volume.”30
While the Biden administration would like to reach a deal in line with the JCPOA, such an agreement seems unlikely. Ian Bremmer, president and founder of the Eurasia Group, believes that the US and Iran will not “get the deal back.”31 A smaller deal, referred to as “less-for-less” or “freeze-for-freeze,” is possible but also unlikely.32
Israel will not stand by passively. Carter believes that the likelihood of Israeli activities that hinder Iran’s nuclear capabilities is 100%.
And, in the meantime, the cauldron will continue to simmer.
China: US-China relations will be a source of uncertainty and volatility for the indefinite future. As outlined in the Annual Threat Assessment of the US Intelligence Community, the Chinese Communist Party (CCP) “will continue its whole-of-government efforts” to:
While the Biden administration would like to reach a deal with Iran, such an agreement seems unlikely.
