Globalization and Its Populist Discontents

Optimistic supporters of globalization hope that 2017 might be seen as turning the tide against nationalist political movements, after France and the Netherlands avoided populist victories in the first half of the year. As investors, we are not so hopeful and believe policy uncertainty will remain elevated due to political shifts across the globe.

The same three forces we cited at the start of the year continue to dominate the geopolitical debate:

1. Protectionism & Weaker International Governance
The recovery in trade growth should not obscure the larger picture of a continued rise in protectionism. The death of trans-Atlantic and trans-Pacific (TTIP and TPP) free trade deals came as expected from the Trump administration, and risks remain over a potential escalation in trade wars. Yet the immediate concern is less about enacting substantial trade barriers and more about the erosion of global governance. Investors need to pay heightened attention to geopolitical shifts, especially in US–Chinese relations, as these developments may have more predictive power than existing international frameworks. Above all, in the event of economic or geopolitical shocks, there would likely be less international policy coordination than in the recent past.
In plain English, it would be harder to restore market confidence as global rules are continually undermined.
Economies most exposed to globalization thus have more to lose than relatively closed economies.

2. Populist Politics
European elections in the first half of 2017 provided a sigh of relief with their market-friendly outcomes.
There has been a cyclical improvement in developed and emerging economies alike, yet we see little evidence that the underlying forces driving populism have abated.
Populism in developed markets and the authoritarian concentration of power in emerging markets continue to cast a long shadow. In developed markets, antiimmigration and interventionist measures could undermine competitiveness or distort markets. In this context, the US administration is not really following the populist playbook and is instead lessening intervention by pursuing a deregulatory approach. Yet across developed markets, policy unpredictability characterizes the investment environment. In emerging markets, the increased politicization of business has investors worried, as do restrictions on information flows that can impede proper price discovery for assets. The quality of policymaking will be a greater differentiator among all markets going forward.

3. Fiscal Stimulus
One potential upside from populist pressure was the expectation of more fiscal stimulus — at least in infrastructure investment, where there is broad consensus of the need to spend more across the globe. However, as the Trump administration has become increasingly mired in controversy, the prospect of meaningful fiscal stimulus has receded further in the distance. The US is likely to concentrate fiscal stimulus now on tax cuts. If poorly designed, these would not translate effectively into higher growth. Most national politics will likely remain unconducive to larger fiscal reforms beyond short-term stimulus.

Emerging Markets Policy Overview
For many emerging markets, the remainder of 2017 will be a challenge in coping with the gradual increase in interest rates in the US and a stronger dollar. Even countries without a pegged currency have found themselves forced to tighten monetary conditions in order to limit exchange rate depreciation and inflation.
Aside from China, more emerging markets are likely to constrain fiscal spending than expand budgetary outlays, particularly among commodity producers still coping with low commodity prices. Regarding structural reforms, as mentioned above, policymaking in emerging markets has not suffered as much as in the developed world. Globalization has largely benefited those countries that have integrated into global markets, so there are fewer backlashes on that front. At the same time, weaker global growth lessens the incentives for difficult reforms ahead. Moreover, as we have seen with Brazil, political scandals can grind reforms to a halt.

Geopolitical Risks
Markets had exhibited a remarkable degree of complacency during the early part of 2017 before the renewed rise in US policy unpredictability. This was mainly due to benign outcomes in European elections and the perceived normalization of the Trump administration based on his foreign policy appointments and lack of adherence to major campaign promises. In addition, great power relations between the US, China and Russia now appear slightly more predictable than in January, though increased tension with North Korea remains a wild card. In our view, the geopolitical risk drivers we identified at the start of the year will remain in place for the rest of 2017 and next year.

Global
Despite Trump making the shift from campaigning to governing, US foreign policy could still be destabilizing as his multiple failures in domestic policy — for example, health care reform and the budget proposal — and intensifying investigations of his administration push him to look for initiatives abroad where he can act without legislative battles. The risks of misjudgement in the Trump administration or an international adversary remain considerable, which could lead to temporary asset price shocks.

North Korea
The regime in Pyongyang would have generated headlines under any US administration, but the risks of miscalculation across all actors (US, China, North Korea and South Korea) are higher than at any time since Kim Jong Un took over power in late 2011. Assuming no extreme event, even smaller tensions could repeatedly boost demand for “defensive” assets.

Europe
So far, 2017 has been the year when elections did not bring about negative surprises. The prevailing victories of centrist leaders in the Netherlands, France and Austria — along with the setback for the hard Brexit position in the UK general election — suggest that election worries will not re-appear until early 2018 when Italy goes to the polls.
There, the election of an anti-EU government would lead to dramatic market reactions. This could already be felt in the second half of 2017 as the ECB begins to withdraw monetary support and the election date approaches.
Despite major waves in headlines, Brexit negotiations will have limited impact until 2018 when the contours of a transitional and permanent agreement become clearer.

Middle East/Ukraine
Ongoing conflicts could see further escalation. Of particular concern remains the Syrian conflict, with related questions over stability in Turkey, which may fail to maintain the easing of refugee pressure or Western sanctions on Russia.

Venezuela
The political and economic impasse in Venezuela is reaching a boiling point. Although Latin America is generally exhibiting resilience, Venezuela still offers potential spillover effects depending on how the country navigates bankruptcy and political change. Sovereign defaults are rarely viewed entirely on their own, and since Venezuela is an oil producer, this could be relevant for both bond and commodity markets.

Elliot Hentov, Ph.D. – Head of Policy and Research, Official Institutions Group – State Street Global Advisors