To say that 2024 is the year of elections is an understatement. By the end of this year, countries accounting for 40 per cent of the world’s population, 60 per cent of global economic output and 80 per cent of the value of global equity markets will have elected new leaders and governments. Experts in political risk assessment have never been busier.
Given the unprecedented scale of electoral contests around the world this year, it was only a matter of time before unexpected outcomes materialised. Since the beginning of this month, a succession of political shocks in both developing and developed economies have roiled financial markets.
While the causes and circumstances of the upsets differ, the common thread is acute social and economic grievances which make it difficult to implement much-needed structural and fiscal reforms, strengthening the appeal of populism and nationalism.
In India, Prime Minister Narendra Modi’s ruling Bharatiya Janata Party (BJP) surprised pundits by losing its outright parliamentary majority, forcing it to seek coalition partners to govern. While this allays concerns about his authoritarianism, it puts more pressure on the new government to increase spending on welfare and could impede progress in tackling contentious land and labour market reforms.
In Mexico, the larger-than-expected share of the vote won by the governing Morena party leaves it just short of the two-thirds majority needed to make controversial changes to the country’s constitution that would remove critical checks on power and entrench the party’s populist policies. While Indian stocks have recovered, the Mexican peso has fallen nearly 10 per cent versus the United States dollar since the end of May.
Yet it is the stronger-than-anticipated gains by far-right parties in France and Germany in the European Parliament elections that are likely to prove more consequential. Marine Le Pen’s Rassemblement National and the Alternative for Germany thrashed the centrist parties that form the current national governments in the two biggest economies in the European Union (EU). French President Emmanuel Macron even felt it necessary to dissolve parliament and call a snap election in a high-stakes gamble which could backfire.
Although centrist parties remain the largest group in the European parliament, the anti-establishment, anti-immigration, anti-green and Eurosceptic populists are moving into Europe’s mainstream. The gap between French and German 10-year bond yields – one of the most closely watched gauges of risk during the 2010-12 euro zone crisis – has increased to its highest level since 2020.
Renewed concerns about political risk will increase investors’ sensitivity to the most momentous election this year: the US presidential race. While former US president Donald Trump was found guilty on 34 felony counts, he still looks frighteningly electable and is ahead of US President Joe Biden in some key battleground states.
Markets have so far shown little concern about the prospect of a second Trump term. The benchmark S&P 500 equity index continues to hit fresh record highs while gauges of volatility across major asset classes remain at subdued levels. This raises the question: do investors care about political risk, and if not, should they?
37:07
What if Trump wins?
What if Trump wins?
Ignoring or downplaying national politics can be costly. There is plenty of evidence showing the damage populist governments’ policies have inflicted on their own economies and the rest of the world.
Britain’s decision in 2016 to leave the EU and then insist on the hardest of Brexits has done irreparable harm to the country’s trading relationships and undermined economic and political stability. In the first quarter of this year, Britain’s output was just 1.7 per cent above its level in the final quarter of 2019, the second lowest growth rate among the Group of 7 advanced economies. While the Covid-19 pandemic is partly to blame, it is indisputable that Brexit has been a drag on growth.
Trump’s protectionist policies, meanwhile, proved damaging to many leading emerging markets. JPMorgan notes that “US elections used to not matter much for [emerging market] assets, until 2016 showed how much they can.” From the day Trump announced his candidacy on June 16, 2015, to their weakest levels during his presidency, the peso and the yuan fell 46 per cent and 21 per cent against the US dollar respectively, JPMorgan notes. Again, other factors were at play, but US politics exacerbated the sell-off.
On the other hand, there is strong evidence that markets can perform well during periods of populist or nationalist rule. The S&P 500 continued to rise for much of Trump’s presidency while many large developing countries with market-unfriendly governments, including China and Mexico, have enjoyed periods when asset prices rose sharply for sustained periods.
04:47
Could a far-right shift in the EU parliament change its relations with China?
Could a far-right shift in the EU parliament change its relations with China?
It is not politics per se that worries investors but rather unforeseen and consequential shifts in policy. Giorgia Meloni, Italy’s far-right prime minister, has governed more pragmatically than markets expected. Some investors appear to believe Le Pen’s party would do the same if it took power.
This is debatable. What is clear is that Italy and France are subject to the policy constraints of euro zone membership. The US, on the other hand, enjoys more freedom, mainly because of the US dollar’s role as the dominant reserve currency. This increases the scope for political recklessness, heightening the risks of a second Trump term.
Trump’s threats to exert more influence over the US Federal Reserve should be taken seriously. TS Lombard believes the golden age of Fed independence came to an end some time ago. While even Le Pen appears to have backed off on demands for a “Frexit”, Trump is doubling down on his extreme populism. The US election is the mother of all political risks.
