The rise of populism and its impact on markets constitute a typical case of ‘reflexivity’, whereby cause and effects get intertwined in a complex circular relationship.
One can trace the source of this interaction back to the early 2000s, when the US policy makers decided to treat by super-accommodative policies the demise of the TMT bubble and the perception of risk to markets and to the economy that the 9/11 terrorist attack caused. This treatment pushed up consumption and financial assets valuations but encouraged leveraging, financial engineering, banks' risk taking which in turn fed excessive mortgage lending. The resulting 2008 credit crisis made markets crash, created a new recession risk, which was then treated with even looser monetary policy.
This long period up until today therefore has been characterized by debt-strapped Governments which have felt unable to address economic activity issues, and have therefore passed on the responsibility to Central Banks to manage the recession threat. Central Banks action has in turn mostly led to a rise in the price of financial assets, while wages and economic activity remained very subdued.
This unilateral surrender by Governments to Central Banks, and the resulting rise of inequality between wage-earners and asset owners has fed a major level of popular discontent. Democratic governments have therefore been very challenged in elections. This created a unique opportunity for populist parties to blame the system altogether, and propose easy solutions, targeting various scapegoats, ranging from immigrants to Brussels, China, Mexico, etc.
Such a populist platform has won the day in the US. Initially markets assumed that the neo-mercantilist program would be implemented. This pushed up the USD (logical consequence of a reduction in the trade deficit and capital inflows) and pushed up the US equity markets (because of tax cuts). But the check and balances of US institutions are such that the implementation of this platform is itself being very challenged. Promising to spend more on defense and infrastructure and to tax less won the elections, but trying to deliver on it is quickly facing limits. At this rate, discontent could come back again soon, and create new political tension. The USD has already come back down.
Populist arguments also won the argument on Brexit, but as we are talking about one unique, although far-reaching, decision, it will be implemented. Therefore the UK economy will indeed have to face the economic consequences of the political decision to leave the European Union. Such consequences might well include a currency weakening further (because capital outflows don't allow to fund a very large current account deficit), pushing up imported inflation, thereby hurting consumers. Jobs could also be lost to the benefit of EU countries. Therefore here, it is not the abandonment of populist promises, but to the contrary the cost of upholding those promises that could provide discontent again. As opposed to what Theresa May is saying, no deal would be a lot worse for the UK than a "bad deal". This puts the UK in a weak negociating position. The Sterling pound could weaken further and fuel a spiraling impact on inflation and consumption.
Interestingly, all this is happening at the same time as a broad economic recovery. So that markets have the luxury of first enjoying the economic cycle, and worry about the market consequences of populism later.
When the economic cycle rolls over, the risk for markets is that, without that safety net, the shortcomings of populist platforms will start biting. Unfounded hopes, or hidden economic consequences will show, and markets will need to reprice.
Happily, France did not chose the populist route. But equally, the reasons that brought about populist pressures are still there (mediocre economic performance, inequalities, joblessness). If the more courageous alternative fails to fix the problems, the temptation to believe demagogic programs will come back with a vengeance. Economy and politics have entered a circular cause-and-effect relationship. Markets will need to watch carefully what comes out of it in the coming quarters.
Didier Saint-Georges - Managing Director and Member of the Investment Committee - CarmignacBLOG COMMENTS POWERED BY DISQUS