Weekly Economic Briefing

Risky Business

23 May 2017


Geopoliticals stole the spotlight last week after months of simmering tensions. Two events sparked market volatility and a renewed attention to political risks: in the US, reports surfaced of a memo written by former FBI Director James Comey claiming President Trump asked to stop the investigation into his former national security advisor; in Brazil, bribery allegations against president Michel Temer sparked uncertainty about a potential second impeachment trial in less than a year. Both events carry similarities in that they threaten to derail a policy agenda that underpins expectations of faster growth. Until last week markets have been poised to look past most political risks: volatility remained at depressed levels (see Chart 1) and equities showed continued strength. However, the events of last week upset some of the calm, with risk assets, even if temporarily, under pressure. Is political uncertainty poised to have a more detrimental impact on the growth outlook or have markets been right to downplay this?

Perhaps a key reason why the markets have been discounting political risks stems from the fact that recent 'tail events' have turned out less negative for economies than most observers expected – Brexit being a prime example. The global economy is in the midst of a synchronised improvement and 'animal spirits' may trump geopolitical concerns. A cyclical upswing among the largest developed and emerging economies could bring about stronger activity despite lingering political concerns. So what would it take for political uncertainty to affect the growth outlook? In line with our political risk framework, prolonged uncertainty can have an impact on the economy through delayed business investment, lower market sentiment and higher risk premia in asset prices; however, institutions matter. A crisis of confidence in the White House need not have as much of an economic impact as a scandal in Brasilia. Take for example the resignation of Nixon, the Clinton impeachment or the Iran Contra scandal, in those cases the impact was short-lived and broader macro factors played the more prominent role. A new impeachment in Brazil could risk prolonged uncertainty and a double-dip recession; however, a distracted presidency (or worse) in the US may merely result in a more assertive Congress with a similar policy agenda.

Lower for longer?

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