Posts tagged ‘political risk’
Think “political risk in Europe” this year and you would most likely have thought about the Brexit vote. It is of course true that Britain faces an uncertain future, and that Brexit will have consequences for the EU too. But it is far from the only game in town.
On Sunday week the electors of Hungary will cast their votes in a referendum on the issue of migrants. Specifically, they are being asked if they accept the EU’s allocation of a migrant quota to Hungary without the consent of their national parliament. The most recent opinion polls suggest that anywhere from three to four percent of citizens are inclined to vote, “yes”. Barring a miracle, Hungary is about to throw down the gauntlet to Brussels in a few days. This has already appalled one or two other EU members: Luxembourg’s most senior diplomat has called for Hungary to be expelled from the Union altogether. In response the Hungarian government is calling for treaty change (specifically reform of the constitutional Treaty of Lisbon).
The question for investors, of course, is: will markets care about this? Even if Hungary were to leave the EU it isn’t in the euro and is a smallish country, so the answer, in isolation, is almost certainly “no”.
It is equally obvious, however, that the Hungarian vote is not an isolated incident. Portugal was talking about a Greek-style referendum on bailout terms over the summer, though this has yet to amount to an actual plan (and didn’t do Greece herself any good in the event either). And next week the Italian cabinet is to fix a date for a referendum on constitutional reform. The detail here is extremely boring but Prime Minister Renzi staked his political future on the outcome. He has tried backsliding on his promise this week but by turning the referendum into an effective vote of confidence in his government it is being seen as a conduit for Italian euroscepticism. This has gained sufficient strength for the Five Star Movement – an anti-establishment party founded by a comedian which sits in the same group as UKIP in the EU parliament – to be leading the polls. “M5S” does not actually want Italy to leave the EU – but it does want a referendum on the euro. In the meantime opinion polling suggests that the constitutional referendum is balanced on a knife edge.
Will rising Italian euroscepticism, or at least anti-euro feeling, present a challenge to the markets’ confidence? Not in isolation perhaps . . .
The Italian situation might well be complicated further should neighbouring Austria elect Norbert Hofer of the Freedom Party to be her president this December. Mr Hofer, who is currently in a dead heat with his Green Party opponent, once called for the border with Italy to be changed and the province of South Tyrol to be incorporated into his own country. Be that as it may he certainly wants to close the Italian border to migrants. And there is more: the last time the Freedom Party came into power (as part of a coalition in 2000) the EU imposed sanctions. Would they do so again?
Looking to the new year, the Netherlands will hold elections in March. There, another party with “freedom” in its name is topping the polls and its leader, Geert Wilders, once banned from entering the UK for his views on Islam, could end up as premier. He and his party want out of the EU.
Soon after the Dutch it is the turn of the French to vote for their president. Marine Le Pen, leader of the National Front, is almost certain to wind up in the second round vote, probably against a centre-right opponent. Like her father in 2002 she will almost certainly go on to lose, but her share of the vote will be interesting. The National Front is, as its name suggests, a nationalist party and has always opposed the existence of the EU.
Then, at around this time next year, we will have the Germans. The migrant crisis has propelled support for a new eurosceptic party, the Alternative for Germany (AfD) to 16% in the polls. It has been winning seats in regional elections. It looks set to establish itself firmly as Germany’s third party come next autumn. Some of its members have an enthusiasm for Nazi memorabilia and have defended some of the actions of Hitler’s government. The party has not yet advocated EU withdrawal, but it was founded to bring back the Deutschmark and stop Germans having to bail out other member states. It is also implacably opposed to immigration, effectively opposed to the idea of the Schengen area and overtly anti-Islamic.
Again, it is possible that the EU and the euro will muddle through all this. France and Germany are not going to elect eurosceptic governments, yet. Wilders’ lead in Holland is not unassailable – and the collaboration of his main opponents could, in theory, keep his party out of power anyway. It is impossible to predict these things but it does seem unlikely that the single currency will be seen to be facing as much of a threat over the next twelve months as it was seen to be facing at the nadir of the sovereign debt crisis in 2011.
The risk, however, is there.
Apart from the voting calendar there are simmering tensions to consider within the EU bloc. Perhaps most serious among these is the stress caused by the migrant crisis. The “Visegrad Group” comprising Czechia, Hungary, Poland and Slovakia submitted a list of
demands proposals at the Bratislava summit last week which included flat opposition to mandatory migrant quotas. The EU is at loggerheads with Hungary and Poland over constitutional issues; meanwhile the Polish and Hungarian leaders are extremely close allies who hold frequent bilateral meetings. This is a barrier to sanctions which some in the EU would like to impose on Poland. (It is seen as a lesser problem that the current Polish government swept to power last year with the first absolute parliamentary majority since the restoration of democracy in 1989.)
Of course there are external issues to consider too, most notably relations with Russia and Turkey. Even more widely, the Brexit vote, support for Donald Trump in the US and the threat of the Philippines to pull out of the UN among other things might suggest that supranationalism as a concept is struggling at this point in history.
But we don’t need to worry about that. There is quite evidently enough within the EU to worry us already.
In isolation, none of these risks appears to pose much of a threat to the bloc or its currency. Importantly, the result of this is that such risks are no longer remotely priced in. Given what we know about the political calendar over the next twelve months it is hard not to conclude that this represents too high a level of complacency.
As years draw to a close it is customary for market observers to make early Christmas presents of their thematic predictions. Here are this blog’s thoughts on some major considerations for 2016.
Starting with the obvious: monetary policy will enter what has become very unfamiliar territory for some economies, including those of Britain and the US. Expectations are that the Fed will tighten policy by 25bp next week; as we have seen, the Bank of England is not expected to follow until well into next year. But market expectations are for the gentlest upward path for rates in recent history on both sides of the Atlantic. Anything more than this will come as a major surprise.
On a connected point, oil made much of the market and macro running this year. The key futures were making new sub-$40 lows just this afternoon. But the key point is that the average price over the last 12 months is $55 as against around $100 for 2014. For cheap energy to mimic the disinflationary pattern established this year would require oil futures to trade down to $30 and settle there throughout 2016. That is a real possibility. On the other hand, a change in OPEC / Saudi Arabian policy on supply could see the price start to climb again. Even if it manages to hold its 2015 range of about $40-60, that will still be significant as the “base effects” of cheap energy on inflation will fade away. In other words the oil price is set to remain a key metric for the world next year – and is entirely unpredictable.
Talking of unpredictable, the election of the next American President is already making headlines almost a year before the event. It will inevitably hog the political limelight in 2016. But elections and electoral arithmetic in Europe are much more interesting from an investment perspective. In several countries, “right-wing populist” or far right parties are riding high in the polls and they tend to be Eurosceptic. We will see how the National Front fares in French regional elections this weekend but there are national elections brewing elsewhere. In Holland, where an election must be held by March 2017 and if history is any guide will take place earlier, the Party for Freedom is polling in the high thirties. In the meantime the Dutch will be voting in an “advisory referendum” come April on the EU’s dealings with Ukraine. There is room for some mild upset on that front and transformational political change at the European level from Holland come the general election. During 2016 the British referendum on EU membership will also be drawing nearer.
Major equity markets showed degrees of volatility this year not witnessed since the crash and panic of 2011. Several currencies had a turbulent time of things too. With the other themes in mind it appears likely that volatility will again feature in 2016.
This list is not exhaustive but will provide us with plenty to chew on over the coming months. In the immortal words of Louis Pasteur: chance favours the prepared mind!
The ongoing drama over Greece continues to monopolise the financial world’s attention. We will probably find out how it ends – for the time being – in a day or two. In the meantime it has been easy to lose sight both of other potential sources of political risk and of the macro and market undercurrents which as rational investors we of course believe will come to dominate in the end.
Political risk is a difficult measure to quantify and a shock, by definition, cannot be planned for. However we have had some horrible reminders today that terrorism is grievously on the rise. This morning it was the attack on a factory in France; then a bombing in Tunisia; and a suicide attack on a Kuwaiti mosque during Friday prayers. These acts have all been claimed or inspired by the Islamic State.
The growing confidence and appeal of IS became glaringly obvious at the time of the Charlie Hebdo atrocity in Paris. Concerns have mounted since at the numbers of Muslims in European and other “western” countries who have tried to join IS in the Middle East, and who it is feared have been returning to shed blood in their homelands thereafter. And competition between IS and Al-Qaeda has been escalating in an attempt to establish leadership of global jihad. The rise of terrorism and the occurrence of any attack is lamentable but it is this last point which poses the risk to markets: something on the scale of the Bishopsgate bombing of 1993 or the 9/11 attacks eight years later has become a strategic goal for terror.
Meanwhile, the collapse of peace talks over Yemen last week has seen renewed Saudi bombardment of the country as the civil war there grinds on: the war doubles as a proxy conflict between the Saudis and Iran. Internal Yemeni rivalry between Al-Qaeda and the Islamic State is a complicating factor, as is the US drone campaign there against the former (though this is supposed to have been suspended in recent months). Elsewhere, negotiations continue to secure a commitment from Iran that she will not become a nuclear power; there is little encouragement to date that their objective will be achieved. In other words, the perpetual powder keg which is the Middle East has been getting even more alarming this year.
It seems reasonable to conclude that the risk of short-term setbacks to risk assets has increased in 2015. But what of the underlying fundamentals?
Here the picture is more mixed, which is to say, more positive overall. Attempts have been made to portray some of the major equity markets as dangerously overvalued but they do not stand up to balanced scrutiny. The economic outlook has disappointed in some places – most conspicuously in the US – and improved in others, such as in Europe, where even the threat of a Greek default has not noticeably dented confidence this month.
One area which has seen some movement this quarter has been the safe haven bond markets. There has been a marked sell off. The ten year gilt yield has risen by 60bp, the ten year US Treasury yield is almost 50bp higher and the ten year German bund yield is up by 70bp, having reached a low of 0.075% as recently as April. Upward moves in interest rates from the Federal Reserve, and with more of a local impact the Bank of England, have been drawing nearer for some time. The futures markets are currently pricing in a 25bp hike from both towards the end of the year. By then the disinflationary impact of last year’s fall in the price of crude oil will have unwound completely. Indeed, should the price rise between now and December then energy will become a source of inflation again.
Bond markets have a long way to go in many places, including here in the UK, before they start to close the valuation gap with equity. The earnings yield on the FTSE All Share Index is still almost three times the gross redemption yield on the ten year gilt, having averaged 1.8x over the last 20 years and 1.1x in the decade prior to the credit crunch in 2007. To reach those levels again the gilt yield would have to rise to 3.5% or 5.8% from 2.2% today. Furthermore, stock market observers seem pretty convinced that markets will take the early phase of rate hiking in their stride, largely because this is what happened last time. They might well be right – but this is not how things went the time before that (1994 as opposed to 2004) and since rate rises are such a novel idea these days their rediscovery surely poses some measure of risk.
So while the threat of short-term shocks has increased the possible medium-term headwinds from monetary tightening have been blowing closer too. It is doubtful whether most major stock markets are in bubble territory and likely that economic and reported earnings growth have much further to run. But selling on the records rather than buying on the dips appears the more rational approach at this point in time.