Political turmoil in Britain, Italy, Hong Kong, and Argentina highlight the intricate links between swings in financial markets and economic policies.

Political risks and government policies are once again taking a front seat in moving asset markets. The selection of a new leader in the United Kingdom, government instability in Italy, protests in Hong Kong, and elections in Argentina have created a turbulent summer for financial markets. Various new fiscal and monetary policy ideas also emerged over the course of August 2019. Below, we highlight some of the flashpoints where politics, policies, and market movements intersect.

Changing policy milieu in the United Kingdom

Boris Johnson, Britain’s Conservative Party Brexit campaigner, was selected as the United Kingdom’s prime minister in July 2019. It has been a turbulent few weeks for Johnson, who in September suspended Parliament for five weeks. His critics say the move was an attempt to stifle debate on Brexit and allow Britain to exit the EU with no deal on October 31, 2019. Then in early September, British lawmakers rejected Johnson’s bids to hold a new national election and to exit the EU without a deal. We believe Johnson’s government will not last very long.

We believe Johnson’s government will not last very long.

In the midst of this chaos, the new Chancellor of the Exchequer, Sajid Javid, promised more money for public spending, including for infrastructure. In his first speech since becoming finance minister, Javid announced the fastest increase in day-to-day spending in 15 years, with a review aimed at funding departments for the first year after Brexit. His speech took place during the meltdown in Johnson’s Brexit strategy. So, it didn’t receive as much attention as it warranted. Higher spending and lower taxes are not compatible with the existing fiscal framework. These fiscal plans may not be implemented because of the political turmoil. But the announcement is a straw in the wind about shifting approaches to economic policy.

Markets are used to a certain amount of political back and forth, and treat most political headlines as noise. There are times, however, when politics matter a lot for market behavior. In the United Kingdom, we have seen shifting probabilities of a “no deal” Brexit as the new government tests its Parliamentary strength. A “no deal” exit from the European Union (EU) is quite rightly seen by almost everyone as seriously disruptive for the British economy. Some government officials believe this and only use “no deal” as a threat in the misguided belief the threat will secure some concessions from the EU. The political environment in the United Kingdom will remain volatile for weeks, and the risk of “no deal” will not disappear entirely. Therefore, U.K. assets will experience bouts of volatility as these shifting probabilities get priced in.

Italy’s power play

Italy’s Matteo Salvini, fresh from his success in European elections and riding high in the polls, pulled the plug on his coalition government in early August. Salvini, leader of the Lega party, asked for new elections in late September on expectations that he would win. A victory would have put him in charge of the government, allowing him to pursue an ambitious approach to domestic policy (a wider fiscal deficit) and challenge the eurozone’s fiscal orthodoxy. He was outsmarted by his former collation partner, Five Star (M5S), which agreed to a new coalition government with the center-left Partido Democratico. The government is now much more pro-EU and does not want a confrontation with Belgium.

It remains to be seen how stable this coalition will be given the history of enmity between them. But Italian bonds reacted enthusiastically. Italy’s underlying economic problems, however, haven’t gone away. Zero growth will continue in the absence of serious reforms. Salvini remains in the wings, waiting for any opportunity that will be presented by a fracture in this unlikely coalition. This is another example of how shifting political winds matter more to asset markets when growth is sluggish.

Hong Kong — one country, two systems

Another political flashpoint is Hong Kong. The weeks-long protests have many causes, and China’s government is clearly worried. “Once country, two systems,” the sleight of hand that allowed Hong Kong a measure of autonomy from the Chinese Communist Party since Britain gave up the colony more than 20 years ago, does not extend to full democratization. China has probably considered intervening. It is possible the government will do so if the threat to public order and to its political control gets too large.

Hong Kong is an important financial center. Assets in the territory are priced at a level that gives more credence to “one country, two systems” than is appropriate. Direct intervention by Beijing would expose this myth and would have ripple effects across the region. The most recent concessions by the Hong Kong administration were seen by markets as lowering the chances of Beijing getting more deeply involved. While we don’t know if this was the correct assumption, the news was perceived as good and helped risky asset prices.

Assets in the territory are priced at a level that gives more credence to “one country, two systems” than is appropriate.

Elections in Argentina

In Argentina, primary elections produced a result that domestic asset markets had not expected. President Mauricio Macri unexpectedly lost the August vote by a landslide. This foreshadows a probable defeat in October’s presidential election and a possible return to the policies of his predecessor, Cristina Kirchner. Argentina’s international bonds and stocks tumbled, effectively a test of national sentiment before the two-round presidential ballot. The market reaction was violent. The election, quite correctly, was not seen as a choice between Tweedledum and Tweedledee, and thus of no lasting relevance, but as a choice between quite different futures for the country.

Emerging markets have treated events in Argentina as an idiosyncratic shock. There has been little spillover to other politically fragile emerging economies. We are not convinced this is an idiosyncratic shock. Rather, we believe this is further evidence of the political stresses created by slow growth. There is little popular appetite for the kind of pro-growth reforms the Macri administration was pursuing, and the appeal of populism is strong.


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