Regular readers will recall that we’re big fans of Deutsche Bank derivatives strategist Aleksandar Kocic.
Back in September, 2015, Kocic penned a hilariously metaphysical assessment of the Fed’s reaction function in the wake of the market turmoil catalyzed by the PBoC’s move to devalue the yuan the previous month. Kocic described the Fed’s dovish tilt in the theatre context as a removal of the “fourth wall,” a reference to the fact that the committee had explicitly acknowledged its own reflexivity vis-a-vis the market.
In short, Kocic is a really good writer, something that doesn’t seem to come natural to most sellside strategists.
Those who frequent these pages are also well aware of how we feel about populism anno 2017. In short, we think the nationalist fervor that grips the US and Europe has been engineered by false political prophets pushing a xenophobic, isolationist agenda that feeds on fear, paranoia and, quite frankly, ignorance.
We’ve gone to great lengths to explain why the perpetuation of this message is dangerous for markets.
Indeed, you needn’t look much further than Marine Le Pen’s promise to take France out of the EMU for evidence of just how disruptive the triumph of populism could ultimately be. A French redenomination event would almost surely plunge global markets into chaos as everyone from traders all the way up to the ECB governing council would suddenly be forced to negotiate a €1.7 trillion default (which would amount to the largest sovereign credit event in history) not to mention the fallout on the € IG market which is heavily weighted (~23%) towards French corporate credit.
Well on Friday, Deutsche Bank’s Kocic took a stab at explaining why you shouldn’t equate Steve Bannon’s quest to rethink the global political order with “creative destruction” – at least not where “creative destruction” presages something positive.
As Kocic writes, “the populist narratives that emerged in the last years [have an] intrinsically protectionist backbone with an emphasis on borders and boundaries, with increasing economic rigidities [and] imply suboptimal allocation of capital [which is] not constructive for economic growth.”
Via Deutsche Bank
Parliamentary elections in Western democracies are defined by the existence of two similar mainstream parties and a numerically dominant center. The elections are won through defections between the left and right center, while the role of the fringe and populist voices was effectively aimed to re-center the center. As a consequence, democratic elections were (most of the time) peaceful and nondisruptive with hardly any market volatility around them.
This has been the case until last year. The increasing visibility and the following mobilized by alternative populist parties in recent years alone has destabilized the political process with politics has becoming one of the main sources of market volatility. As early as 2013, political poll results began to show patterns which unambiguously indicated that people in developed democratic economies were growing increasingly disenchanted with the ruling elites. The data seemed to suggest a high chance of an outsider candidate or party winning the elections. This has had a nontrivial impact on the subsequent political campaigns, political landscape and the democratic process in general.
The populist narratives that emerged in the last years are a result of the new identity politics with strong indication of their disruptive character in the context of the existing market functioning. Their intrinsically protectionist backbone with an emphasis on borders and boundaries, with increasing economic rigidities, implies suboptimal allocation of capital and is not constructive for economic growth.The initial embrace of populism has gained traction based largely on a belief that political disruption, as a mode of change, deserves the same status that creative destruction used to have in the post industrial era with resulting political entropy becoming one of the main sources of market volatility.
In the months following Brexit and the US elections, we learned that on this new socio-political landscape the skill set required to win the elections seem to be quite different (and not necessarily overlapping) with the skills required to govern. It has gradually become clear that candidates’ appeal which arises from their outsider’s position does not necessarily carry over beyond their victory: While being confrontational and anti-establishment might create an advantage during the campaign, it becomes an impediment once the elections are won and the candidate is in the office.
Although in the UK, it is still premature to talk about the long-term consequences of Brexit, there seem to be signs of the “buyer’s remorse” whose overtones are difficult to ignore. In the US, on the other hand, we have accumulated some, albeit limited and preliminary, data about the convertibility of the populist narrative — the link between populist promises and policies and actual deliverables. In the last month, the market has been taking a pause and reassessing the preelection enthusiasm. The new “data points” warrant a recalibration of the convertibility of the populist narrative. This recalibration is likely to create political headwinds for the advancement of populism in Europe and force a reassessment of its merits and future success in general.
Note the implication from the underlined passage above. This story you’ve been hearing about a “reset” of Western democracy being akin to “creative destruction” is nonsense. It does not, to quote Kocic, “deserve the same status.” I’ve been saying that for as long as I can remember.
Aleksandar goes on to highlight something else we’ve been keen on emphasizing ourselves: namely that the transmission mechanism between politics and markets is FX and the more specifically, JPY crosses. To wit:
In our view, the first order transmission mechanism of politics to the markets is likely to be through the FX channel with JPY crosses, especially EURJPY, anticipating the most dramatic change.
Ultimately, you’d do well to remember that when this is all said and done, UK voters aren’t going to be the only ones with “buyer’s remorse” if populism’s current incarnation manages to shake off recent setbacks and reassert itself as the political movement with the most global momentum.
Understatement of the year: “the skill set required to win the elections seem to be quite different (and not necessarily overlapping) with the skills required to govern.”