Last Wednesday, Andy Burnham’s Chancellor, John Healey delivered his budget, which was a tame affair. Fiscally, the UK is in as bad shape as France, but without the good food, impressive infrastructure and lavish pensions. Though at least it has a ‘keep calm and carry on’ perspective, unlike the anarchy and vandalism that has been visited on French cities. Markets shrugged at the Healey budget, much of which had been signalled in the press and social media, and above all, with very limited fiscal space, he had little scope to do much.
It wasn’t always the case. One of the great tasks of City economists was the parsing of the Budget. Budgets were great set-piece affairs, dramatized by Chancellors like Ken Clarke sipping whiskey as he delivered the Budget. Trolleys of sandwiches (and a few whiskies) would be delivered to economist’s desks as they made sense of the Budget and then transmitted their views to gilt, currency and equity investors, sometimes by fax. The Budget was a frontpage story for nearly all newspapers.
An early, formative career experience of mine was an internship in the City of London, where I sat a few metres away from the office of Gavyn Davies, then (and now) a very prominent economist. He was instrumental behind the scenes, in spurring some of the early policies of the New Labour government of the 1990s, such as the radical move to give the Bank of England its independence. That was a market moving event.
In contrast to the Healey budget, another market moving political event this week was the initial 24% drop (in dollar terms) of the Brazilian stock market in the wake of the surprise victory for ‘Lula’, and the 3% drop in the Tel Aviv stock market following Wednesday morning’s election result.
The latter two events suggest that either investors do a poor job of forecasting elections or more importantly, that politics is ‘back’ as a material factor for market returns. The next test of this will be the US midterms, which we previewed two weeks ago (MidWay), where a strong swing to the Democrats (i.e. Senate majority) may see a correction in AI stocks, crypto and the price of oil (my instinct is that a Democratic Senate would hasten an end to the Iran War, and the White House might be happy with this).
Though it is intuitive that politics and policy will drive markets, especially ‘macro’ assets like currencies and bonds, it has not been the case in the past two decades. First, the period of globalization produced long periods of growth, with generally low inflation and an absence of wars. During this period, politicians were generally well behaved and stuck to the rule of law and world institutions. Market volatility tended to be generated by hubris and excessive leverage.
Second, in the post global financial crisis era, the near permanent application of quantitative easing by central banks dulled the responsiveness of investors to politics and geopolitics, and to a certain extent investors operated under the belief that the market reaction to bad news would be underwritten by central banks. That era is now over. Inflation is back, central banks are raising rates and the world is gripped by several major conflicts, plenty of smaller ones (across Africa) as well as the evolving Russian hybrid war on Europe.
Also, there has been a marked deterioration in the quality of policy making, and a concomitant rise in geopolitical risk. The Economic Uncertainty Index produced by three American economists is off the highs it attained in March ‘25, but still well above its historic average, and other geopolitical risk indicators are extended. In particular the fiscal constraints that most of the major governments face, will increasingly produce popular discontent (in the case of France), or unorthodox policy moves (Donald Trump’s tariff policies). Further, in a world that has gone from ‘open’ trade to a mindset conditioned by ‘sovereignty’ and resource bottlenecks, straightforward conquest is back on the menu of geopolitical strategies (e.g. Venezuela).
My intuition, based on previous research, is that in the expansion phase of the business cycle, company specific factors like earnings matter most to markets, but in downturns, country-specific factors (politics, policymaking) exert a bigger influence. For the time being the world economy is resilient, and in growth mode under the steam of AI led capital expenditure. But a phase of weaker growth and earnings, coupled with higher inflation may well mean that political risk exerts a greater role in asset prices like commodities and bonds, and in some cases asset prices are driving politics.
As we head into 2027, a range of events and assets comes to mind – peace ‘deals’ in Ukraine and Iran would impact energy and bond markets (interestingly Pakistan, Saudi Arabia, Turkey and Iran have held talks in Tehran recently), elections in Spain, possibly Germany and of course France will produce trades in banks and bonds. A ‘black swan’, to misuse Karl Popper’s term, might well be the machinations within the Chinese Communist Party as it tries to manage the ongoing deflation of the property bubble, the impact of this on house prices, and a tax crackdown on overseas assets of wealthy Chinese. This has started to impact the Chinese stock market and may soon rebound on the Communist Party.
Have a great week ahead Mike.
