2024: a roadmap of geopolitical risk

Never have more people voted, never have people been more misguided. We look at why, for investors, this coming year of unprecedented geopolitical risk cannot be understated, with the direction of global democracy directly impacting risk premia in government bond markets.

The avalanche of anticipated elections have major implications for fiscal policy. With incumbent governments vying to secure the support of their voter base, fiscal consolidation efforts are often thrown to the wayside in favor of more generous spending measures in election years. This comes at a point when counter-cyclical fiscal adjustments are critically required globally, to maintain debt sustainability and open policy space for future economic downturns.

Therefore, it is not only a question of fiscal risks into elections, but also what comes after and how can investors navigate this roadmap of uncertainty.

The Brits

In the UK, the Conservative Party is headed into autumn elections well aware that – in the absence of a bold manoeuvre – the chances of retaining power are slim. However, policy space is severely limited. Persistent inflation prevents the Bank of England (BoE) from easing monetary policy to support the economy, while disappointing growth and high debt levels have exacerbated fiscal imbalances. Additional fiscal measures are certainly in the pipeline in the run-up to elections, with notable income tax cuts expected in the March budget; but perhaps of greater concern is where fiscal policy is heading under a Labour government.

What does this mean for investors?

Fiscal austerity doesn’t much align to the party’s ideology. Heightened fiscal risks extending into year-end suggest opportunities to short gilts in anticipation of additional risk premia being priced into yields, with the longer end particularly vulnerable, given supply risks.

Over the pond

Meanwhile the US is headed hot and heavy into its presidential elections, with arguably the worst fiscal situation of advanced economies. The Biden administration has pumped up the economy with massive fiscal spending, which has arguably been the most significant driver underlying the outperformance of the US economy versus the rest of the world over the last few years.

Going into another hotly contested Democratic election, this dynamic is not going to change. For investors, this means that the US economy will continue to be supported by fiscal spending over the year, which will further encourage the persistence of services inflation in the face of the Fed’s tightening cycle.

How can investors look to position themselves?

Such a backdrop suggests caution against the market front-running the Federal Reserve (Fed) and pricing in an aggressive easing cycle too soon. We see value in trading curve steepeners, and we look for the market to price a higher-term premia to account for sticky inflationary pressures and heavy fiscal measures, in the context of record net treasury supply (accounting for the Fed’s quantitative tightening).

It’s also critical to question: ‘What next?’ and ‘Where do we go under a Trump administration?’

The fiscal constraints in the US will likely continue to be stretched to enable further stimulus to the economy. Although Republicans publicly appear to want to shrink the government, in reality it seems they have little appetite for austerity measures.

Trump can be expected to continue his patriot’s parade with a slew of additional import tariffs, aggressive foreign policy, and putting a stop to the external funding for issues like Ukraine. However, if he wins with the majority in the house, his first action will likely be to extend tax cuts.

Risks from US-China relations will gain prominence, as it coincides with a concerted shift in Xi’s priorities from the economy towards an emphasis on security. This favours a strong dollar, particularly against more vulnerable neighbors like the Mexican peso (where Trump will push against immigration from the Southern border), and makes Ukrainian credit look vulnerable.

On the other hand, Israel stands out as a beneficiary, given funding, and support for Israel will continue to be enforced, a move supportive of credit spreads. However, the election likely won’t be a central trading theme by the market until after the March verdict on Trump’s candidacy.

Back to Europe

Shifting to Europe, the expected rise of right-wing populists in the European Parliamentary elections is far less of an investment concern. Instead, we look to Europe as a beacon of stability in a year of high uncertainty, safeguarded by a solid European framework. A centrist coalition will anchor the next legislative cycle; it’s been experienced time and again that nationalists don’t work well together. This will likely be supportive of European spreads, despite external risks from the Ukraine conflict and China.

Now to emerging markets

Elsewhere, across emerging markets election uncertainties will lend to market volatility and risk premium. Opportunities stand out to us in Poland and Romania. In Poland, the new government coalition under Tusk will likely further solidify its position in local elections this Spring. While a victory comes at the cost of higher fiscal spending, reducing the control of political party, PiS at the local level enhances their ability to restore rule of law, secure EU funding, and further promote Poland’s appeal for foreign direct investment. All of which should add to appreciation pressures on the zloty.

In Romania, general elections are expected to result in policy continuity with the re-election of the current government. Reduced uncertainty and a stable government are a positive for Romanian credit spreads.

Looking ahead

Periods of persistent volatility present huge opportunities for investors. We believe the political landscape lends itself to investors taking an active approach, able to effectively maneuver geopolitical risk.