Political volatility is becoming an economic risk

Illustration of two dice with dollar and cent signs, exclamation points and an outline of America along each side

Illustration: Natalie Peeples/Axios

The world’s wealthiest economy — with the deepest and most liquid market — is a riskier place than it used to be for investors. And politics is a big reason.

Why it matters: “Political risk” is an investment thesis used to evaluate developing economies with histories of weak governance and social instability.

  • But the Jan. 6 riot, widespread mistrust of institutions and a polarized electorate are symptoms of an increasingly anfractuous politics making policy decisions less predictable for investors.
  • Perennial fights over the debt ceiling are one example, but some say things could get considerably worse, in ways that may have a more pronounced effect on the U.S. as a draw for global capital.

In an environment characterized by cynicism and mutual mistrust, the peaceful transition of power and the absence of politically-inspired violence – things that underpin a free market democracy – can’t be taken for granted.

Driving the news: The photo finish of the midterm elections – which sent the markets into a brief tailspin – showed just how polarized and unpredictable things have become.

  • According to Strategas’ head of policy research, Dan Clifton, Tuesday was the 8th time in 9 consecutive elections “that voters have removed the party in power,” punctuating “the most political volatility since the civil war, and that volatility creates [market] uncertainty.”

The turmoil that recently engulfed the United Kingdom — forcing the humiliating ouster of its prime minister just weeks after she took office — underscore how markets are reacting dramatically to politics and policy. It means political leaders can’t be complacent about growing social and economic risks.

  • “The only thing that makes currencies move 30-40% is a fundamental change in the politics,” Joseph Lewis, Jefferies’ managing director and head of corporate FX hedging, told Axios in an interview, referring to the U.K. pound’s plunge to near-parity with the dollar.

Populist movements like Brexit and the diminished appetite for free trade and the movement of capital are making things even dicier.

  • “With the unraveling of globalization and increase in protectionism…that policy by definition will seep into the FX market, will change how you move capital in and out of countries and how you do business,” Lewis tells Axios. Once people “start to step out of the global club, all bets are off.”

Yes, but: Clayton Allen, U.S. director at Eurasia Group, explained to Axios in an email that, “for domestic investors, there would seem to be little reason to change the way they perceive the U.S. relative to the rest of the world.”

  • The world is becoming more volatile, but the U.S.’ relative strength in institutions…means that this is still the first option for investment,” he said.
  • “The same dynamic looks different when you are looking at the U.S. from the vantage point of an increasingly destabilized and decentralized world, and even a less stable U.S. likely appears more attractive as a haven from global trends than other markets.”

The bottom line: For all its flaws, the U.S. is still what most investors consider the cleanest dirty shirt in a global economy wracked by instability. That said, “it does mean that investors must consider political risk more heavily in the context of the U.S. than they have in decades, perhaps ever,” Allen says.

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