Alexander Friedman writes: Central bank policies have moved from supporting the markets to potentially destabilizing them. Now markets are turning to structural reform and fiscal policy for assistance. In this light, current price movements should be viewed through the spectrum of geopolitics. And it is not a nice view.
Nowhere is this more evident than in the oil markets, where prices have collapsed, with both Brent and Crude now hovering around the $30-per-barrel level. In January, the correlation between crude oil prices and the S&P 500 reached the highest level since 1990.
It has become increasingly clear that supply dynamics, rather than falling demand, explain the drop from $110/barrel since the summer of 2014.
These supply dynamics are shaped by politics. Daily headlines about potential coordinated measures by the key oil-producing countries fuel oil-price volatility and define risk appetite across financial markets. Yet the politics is so confused that coordination appears unlikely, at best; the Iranian oil minister recently described a potential OPEC production freeze as a “joke.”
Currency policy remains confused, while newly introduced (and soon withdrawn) stock-market circuit breakers have accelerated market falls, as investors try to sell shares before liquidity disappears. Moreover, purchases by state-owned financial institutions, together with bans on sales by large institutional shareholders, cannot remain permanent features if the market is to be truly free.
Labile politics are increasingly driving outcomes in other emerging markets as well. In Brazil, the government struggles to balance its populist agenda with lower commodity prices, dwindling growth, and persistent inflation.
In Russia, too, politics has aggravated the negative oil-price shock. Western sanctions have contributed to an already slowing growth trajectory, and are threatening Russia’s ability to raise debt capital in global markets. The ruble has plummeted 130% since 2014 began, and GDP in 2015 contracted by 3.7%.
Yet Russia is a star performer compared to Venezuela, where President Nicolás Maduro’s government has overseen the economy’s total disintegration.
In Europe, the efficacy of the European Central Bank’s monetary policies is waning as the political scene becomes increasingly fragile.
Meanwhile, the migration crisis threatens Germany’s government; splits are now deepening within Chancellor Angela Merkel’s party.
In Southern Europe, Spain’s recent elections were inconclusive, and the absence of a stable government could derail an economic recovery that gained traction in 2015.
Turning to Japan, the strength in equities since Prime Minister Shinzo Abe took office has been founded on his “Abenomics” strategy’s “three arrows”: monetary stimulus, fiscal stimulus, and structural reforms. The Bank of Japan has launched one arrow, expanding the monetary base to ¥80 trillion ($710 billion). But momentum has faded considerably, as investors wait for the structural reforms needed for sustained improvement in economic, and market, fundamentals.
Financial markets, which seek stability and predictability, are struggling to find it in the politics of the world’s largest economy.
History may not repeat itself, but let’s hope it finds its rhyme. Back in the 1990s, the US economy stabilized and then surged forward, driven by accelerating productivity and abetted by sound monetary and fiscal policy. But economies may prove to be easier to mend than today’s dysfunctional politics, which may be part and parcel of the “new normal.”