For this week’s newsletter, we focus on the factors that drive geopolitics, markets, and thus investment considerations. First, we look at the expanding China-Russia relationship against the backdrop of global rearmament. Then, we examine how geopolitical and economic risks can make influence investment decision-making. We then move to a discussion of the prospect of a wider conflagration in the Middle East due to Iran-Israel tensions. To end this week, we touch on the risks of a North Korean attack on South Korea and how the deepening relationship between Pyongyang and Moscow could drive this.

The Growing China-Russia Partnership Amid Global Rearmament

The US and Its Allies Face a $10 Trillion Reckoning in the Race to Rearm

Enda Curran, Natalia Drozdiak, and Bhargavi Sakthivel, Bloomberg

Putin and Xi’s Unholy Alliance

Alexander Gabuev, Foreign Affairs 

Despite initial doubts about the durability of the partnership between China and Russia, the two nations are now more aligned now than at any time since the 1950s. This partnership, described by Putin and Xi as a “partnership without limits”, has been primarily driven by a deepening schism between the West and both countries, as well as economic complementarity and shared distrust of the United States. Bilateral trade between China and Russia has grown significantly, with China becoming a major market for Russian exports and a key source of imports for Russia. Military cooperation has also increased with joint activities, including strategic exercises and naval drills. Russia sees China as essential for its economy and military technology needs, especially amid Western sanctions. Furthermore, China’s support helps Russia sustain its aggression against Ukraine. Accordingly, Western policymakers should abandon the idea of driving a wedge between China and Russia. Instead, they must develop a long-term strategy to compete with both powers simultaneously and manage the implications of their partnership for global peace and security.

China and Russia’s partnership is just one of several threats spurring global rearmament. While political leaders have been lauding their progress toward NATO’s 2% GDP defense spending targets, officials focused on security suggest that military budgets may need to mirror Cold War-era levels, potentially reaching as high as 4%, to effectively fulfill the alliance’s objectives. Achieving these targets could result in over $10 trillion in additional defense commitments for the US and its G7 allies over the next decade. The EU faces tough decisions on how to finance increased defense spending while maintaining aid to Ukraine, especially given uncertainties over US support. Expanding jointly-backed euro bonds could be an option to fund this increase. Despite these challenges, NATO members are unlikely to commit to 4% spending any time soon. Nonetheless, this new era of global rearmament poses significant costs and difficult choices for Western governments already grappling with precarious public finances.  

A World Fraught with Economic and Geopolitical Risk Makes for a Volatile Investing Environment

Inverted pyramid of investments needs shoring up

Mohamed El-Erian, Financial Times

American Exceptionalism Is on Display in the Bond Market

Mohamed El-Erian, Bloomberg

The Odds of $100 Oil Are Rising as Supply Shocks Convulse the Market

Lucia Kassai, Sharon Cho, Devika Krishna Kumar, & Alex Longley, Bloomberg

The Gold Market Hunts for Answers Behind Bullion’s Sudden Surge

Mark Burton, Jack Ryan, & Yvonne Yue Li

Popular investment strategies have strayed from a more traditional, long-term approach built atop strong fundamentals to a more opportunistic and tactical one. The shift could be risky in the long run. Experts argue that the traditional approach, grounded in good foundations, allows portfolios to weather market volatility as well as economic and geopolitical shocks. However, the current trend towards short-term positioning relies on better governmental fiscal responsibility and a more stable geopolitical realm. This is not the world we find ourselves in today, with a divergence of economic trajectories across the developed world. For instance, the gap between US and German bond yields (with German bonds usually serving as a benchmark for Europe) is unusually large. It illustrates an “American exceptionalism”, shown most clearly by strong economic growth in the US as Germany fell into recession. US growth has been facilitated by growth-minded fiscal policy toward three crucial sectors for future expansion: technology, life sciences, and energy. Only a major economic shock is likely could derail the US economy and bring the yield gap back down. Investors that are betting on a weaker dollar may want to reconsider their options, as many analysts believe the US is on a much better track for growth in the medium term.

Despite the strength of the US economy, an economic shock could be coming. Recent developments in the oil market have squeezed supply, bringing a resurgence in inflationary pressure. These include Mexico choosing to cut its crude oil exports in an attempt to wean itself off of fuel imports, a deep freeze in the US decreased crude inventories to a below-average level, European oil imports being delayed by Houthi attacks in the Red Sea, and other factors stemming from geopolitical instability. Some analysts believe that Brent crude could reach $100 per barrel for the first time in two years. Demand is staying strong throughout the supply crunch, and is expected to continue due to a pickup in Chinese economic activity and a seasonal increase in summer driving. This complicates the Fed’s fight against inflation, potentially forcing the central bank to keep rates higher for longer (or even raising rates, a prospect seemingly unthinkable just weeks ago). The fear of an economic shock seems to have influenced gold markets as well, with gold prices reaching record highs. Analysts believe that some contributing factors include demand from central bank purchases in anticipation of lower interest rates as well as direct purchases by investors. Even then, the prospects for a dramatic decrease in interest rates is falling as US inflation data keeps coming in hot. Some analysts believe the best explanation is nervous buyers looking to hedge against a global economic hard landing combined with geopolitical turmoil, with gold being used as its traditional “safe haven” role.

Iran and Israel’s Intensifying Hostilities Risks Geopolitical Turmoil

Iran’s Order of Chaos: How the Islamic Republic Is Remaking the Middle East

Suzanne Maloney, Foreign Affairs

The real threat to Israel’s existence comes from Iran, not Hamas

John Sawers, Financial Times

The Israel-Iran Shadow War Reaches a Dangerous New Phase

Ethan Bronner, Bloomberg

The Gaza conflict and its effects on the region serves as a crucial reminder of Iran’s threat to regional stability. It significantly bolstered Hamas’ ability to strike Israel through weapons and training, and in the wake of October 7th, Iran’s allied militias have intensified their operations, emboldening even its non-affiliated terrorist groups. Tehran has opportunistically used the chaos to elevate its influence in the region, following its longstanding playbook of taking advantage of regional volatility. Iran’s strategy of funding militant groups in the region allows it to compete with more powerful adversaries, such as the US. Despite multiple US presidential administrations’ efforts, combating Iran’s strategy has proven challenging. The Biden administration’s efforts to normalize relations between Saudi Arabia and Israel, while sidelining destabilizing actors like Iran, have been complicated by the Gaza conflict. Iran also sees an opportunity to align further with China and Russia, both of which benefit from a US bogged down in the Middle East.

Iran’s alignment with other autocratic powers may bring even greater consequences, given intensifying hostilities between itself and Israel. Historically, their attacks against one another have often been indirect and they’ve managed to avoid direct war escalation. However, the ongoing conflict between Israel and Hamas, along with other militant groups such as Lebanon-based Hezbollah, has increased the risk for a broader conflict. Recently, Iran blamed Israel for an airstrike in Damascus that killed several top Iranian military personnel. Iran’s nuclear ambitions is also seen as an existential threat by Israel. Meanwhile, Israel risks giving Iran a political win due to its carelessness in conducting the Gaza offense, with recent news of World Central Kitchen aid workers being killed by an Israeli strike, which intensified concerns about Israel’s regard for civilian life. Prime Minister Netanyahu may seek to drag out the war as long as he can, as there is little chance of a political reshuffle during conflict. Both sides seem to be testing the other’s limits. If a wider conflict erupts, it could drag in major powers such as the US or Russia, a development with catastrophic consequences for the region and the world.

North Korea’s Partnerships and War Preparations 

Is Kim Jong Un Preparing for War?

Robert L. Carlin and Siegfried S. Hecker, 38North

North Korea is arming Russia and threatening war with South Korea

The Economist 

Kim Jong Un Faces Annihilation in Most Korea War Scenarios

Jon Herskovitz, Bloomberg

Putin’s upcoming visit to North Korea, as reported by the state news agency, marks a significant development in the relationship between the two nations after over two decades. This visit underscores the warming ties between Russia and North Korea, a partnership that is mutually beneficial, with Russia gaining support for its actions in Ukraine while North Korea’s regime is emboldened. North Korea’s continuous testing and enhancement of weapons, including intercontinental ballistic missiles and cruise missiles, coupled with the deepening relationship between Kim Jong Un and Vladimir Putin, who is providing military aid, are significant factors shaping North Korea’s strategic decisions. These dynamics, alongside the potential return of Donald Trump to the White House, could have profound implications for regional stability.

Analysts such as former CIA Officer Robert Carlin and nuclear scientist Siegfried Hecker are warning that one of these strategic moves may be a decision by Kim Jung Un to go to war. These warnings come following Kim’s removal of the goal of peaceful unification from North Korea’s constitution. The shift from bluster to serious threat is rooted in a fundamental change in North Korean policy, which historically aimed to normalize relations with the United States as a buffer against China and Russia. However, since 1990, North Korea’s goal of improving relations with the U.S. has been abandoned. This strategic change, coupled with a failure to understand the impact of the failed 2019 Hanoi summit on Kim’s views, has led to a reevaluation of policy options and a strategic reorientation toward China and Russia. These factors have raised concerns that Pyongyang could be planning a military solution to the Korean question, with potentially catastrophic consequences even in the event of a U.S.-ROK victory in a conflict. If Kim Jun Un were to initiate a large-scale attack, it would likely start with a barrage of artillery aimed at key military, political, and economic targets in Seoul. While most analysts believe that Kim Jung Un is unlikely to seek an all-out war at this time, nonetheless the situation remains volatile and unpredictable.