Expect even more volatility in a super-election year

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Elections could see major turning points in mature markets, not just newly democratic states, argues Elliot Hentov, head of macro policy research, State Street Global Advisors.

2024 will witness the largest number of people voting ever. According to the Economist Intelligence Unit’s Democracy Index, levels of democratic robustness have been declining in recent years across nearly all regions. Nonetheless, elections remain major turning points as financial market events, causing shifts in macro policy settings and geopolitical dynamics.

Traditionally, elections mattered mostly in newly democratic states, where they posed risks to domestic stability and also represented a potential for dramatic policy shifts. This was classically framed as political risk particular to emerging markets, whereas developed markets allowed investors to ignore such risks and focus on narrow policy shifts that would only affect small sub-sectors of capital markets.

Needless to say, we embark on the 2024 global election cycle with an awareness that this pattern belongs to the past. Political risk – not only potential policy shifts but full-on policy reversals – institutional frameworks, political stability as well as position in the global order can now also be at stake in mature democracies. It is worth reflecting on the major themes present across all elections this year without the traditional classification.

Geopolitical transition

First, elections are primarily about geopolitical ramifications. When the world order is stable, individual elections or regime changes rarely impact a country’s role in that order. However, in times of geopolitical transitions such as now, foreign policy becomes a moving variable that can be affected by the respective national leadership. Smaller and midsize countries witnessed that in 2023 (Poland through elections and several Sahel countries via military coups). But when regional or global powers have elections, this can have even wider consequences.

In this regard, the US is obviously the most critical election with the challenger candidate arguing for a re-definition of the US’s role in its global alliance system. Such a change could impose higher fiscal and security costs on US allies as well as widen the risk premium for countries and companies situated along geopolitical fault lines. Few other elections offer similar redefinitions, though the Indian election would theoretically also offer a turning point if a new administration were to take power.

If elections represent an opportunity to shift a nation’s foreign policy, then logically foreign countries have a vested interest in affecting the outcome. These incentives imply that over the course of this super-election year, geopolitical risks should be materially higher than in low-election years.

The macro risk here is that any of the myriad crises escalates to an extent that disrupts trade and production, thereby triggering a global inflationary impulse. This would then upend market expectations of disinflation, rate cuts and a soft landing. Elections are therefore a key barometer of the health of macro forecasts this year and should mean repeated bouts of volatility.

Fiscal policy is more important than ever

Second, the core of politics typically revolves around money. So elections are largely fought over fiscal issues. Now in 2024, the difference is that fiscal policy is more important to the overall policy mix and macroeconomic performance than it has been for several decades.

Figure 1 shows the average share of general government spending in the five largest developed countries (US, Japan, Germany, France and UK), rebased to 2000 levels. It shows that the 2008 financial crisis sparked a one-off fiscal shock that gradually subsided during years of austerity before the Covid-19 pandemic tiggered another round. What is new is the extent of fiscal support and its likely permanence. Fiscal spending is now more than 20% higher than in 2000, so decisions around fiscal priorities have a bigger impact on economic and market performance than in the past.

Figure 1. Government spending has significantly increased over two decades

General government spending of G5 economies (US, UK, Japan, Germany, France), % of GDP (2000=100)

Source: Macrobond, SSGA Economics, BEA, BUBA, INSEE, MOF, StatCan, Isat, ONS
Updated as of 19/1/2024.

Finally, this is not to say that monetary policy does not matter in an election year. It quite clearly does, particularly as central bankers are reluctant to be responsible for economic downturns in the middle of an election campaign. In countries with weaker traditions of central bank independence, one could imagine a clear easing bias in the months ahead of election day. A very limited reflection of this pattern is also likely to be present in the US, compounded by the Federal Reserve’s institutional independence being questioned by one of the presidential candidates.

This is how elections impact all market participants: they offer a defined moment in time to imagine a different trajectory for policy, the economy and markets. Investors will position accordingly.


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