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Politics will be key for financial markets this summer


For those traders focused still on the economic numbers and trying to read the tea leaves of Fed press conferences, don’t look now, but ongoing political turbulence could well be the biggest factor driving equity, debt and even FX markets this summer.

Even the war in Ukraine seems to be subsiding into the background for many trading floors, and risk officers at big funds remain glued to polling data.

The UK goes to the polls this week, but that is widely regarded as a foregone conclusion. The real worry for many traders has been the snap French election. Up ahead, however, is the possibility of further issues around the US electoral process.

French first round prompts relief rally

This morning the euro is rising along with most European equity markets on speculation that the French far right party led by Marine Le Pen may not achieve an outright majority. This development has alleviated fears regarding potential pressures on France’s public finances, leading to higher futures on French government bonds while German bunds have experienced a slight drop. Attention now shifts to the crucial second round of voting on July 7, where the power dynamics in France’s National Assembly will be determined.

“The centre of gravity has shifted and the RN could secure a majority still,” said Neil Wilson, Chief Market Analyst at Finalto. “Thanks to the peculiarities of the French electoral system we don’t know precisely how the vote yesterday translates into seats, but there is no masking the earthquake.”

Projections for the number of seats RN will secure vary. There will be an unusually high number of three-way run-offs due in part to the very big turnout. It is unclear how the Leftists and Centrists will work together to form a ‘Republican Front’ to defeat RN.

So while there is something of a relief rally in European markets this morning, expect more tension as we move towards that French second round.

What about the US election?

Markets are pricing in an increased possibility that former President Donald Trump will defeat President Joe Biden after Thursday’s television debate in which the incumbent looked frail and confused, igniting rumours he will be replaced as the Democratic candidate in these pivotal US elections.

While Trump now looks like he is in a much stronger position that he was just a week ago, the possibility that Biden will be persuaded to step aside before the Democratic National Convention in August should not be discounted. Expect plenty of soul-searching behind closed doors at the White House over the next few weeks.

Traders should note that the VIX index has spiked sharply this morning. Used as a measure of market expectations of volatility in the S&P 500, it has strikingly reversed a five day trend. It will be worth keeping an eye on over the next few days. It will be driven by further news flow coming out of the US political scene.

“The next major catalysts ahead for the US election include the formal party nomination conventions in July and August, respectively, and then a scheduled second debate in September,” commented Swiss bank UBS in a note to investors over the weekend. “Former President Trump, now holding an advantage, may see less reason to offer Biden a second opportunity. The US electorate remains polarized, and we expect to see a great deal of discussion over whether investment portfolios should be re-examined.”

UBS said academic research supports the belief that political affiliation has a direct impact on one’s level of optimism regarding the future direction of the economy. Those who share an affiliation with the party in office are more likely to believe that financial assets are undervalued and respond by increasing their allocation to equities. Conversely, investors disappointed with the outcome of an election often adopt a risk-off strategy.

“This partisan bias is a dangerous element for investors, especially in a politically charged election year, threatening to override one’s objective assessment of risk and potentially skewing investment behaviors,” UBS said. “While the election will be consequential, the US political outcomes are far from the largest drivers of global economic growth and financial market returns.”

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This article does not constitute investment advice. Make sure you do your own research or consult a professional advisor.

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