Four types of political risks arguably move interest rates. First, the perception of fiscal responsibility. If bond holders perceive an increased risk in the government defaulting on bond payments, or not collecting enough in taxes, bond holders will want a higher interest rate before lending the government more money.
Second, the economic stances of a political party may move interest rates. Once upon a time, the Republican Party was perceived as fiscally conservative, willing to slash budgets as an approach to relieving the tax burden of consumers. I believe that facade started to crumble way back in the 1980s with the financing of Ronald Reagan’s 600-ship navy.
Democrats, because of their focus on social spending, have always been seen as spend happy, running up deficits to finance health services, elderly and childcare, and retirement benefits. Ironically, the last president to have balanced a budget and create a surplus was Bill Clinton, who came off more corporatist and centrist than most would want to admit.
Third, elections bring uncertainty thus increases in risks. Election 2024 is no exception. Some pundits believe a Harris win, given her promises of housing assistance, increased child and elderly care, and continuing the negotiations to reduce or cap prices on certain medicines will increase the government’s budget. On the flip side, some observers believe that a continuation of the Trump 2017 tax cuts will also widen the budget and force the government into the market for loanable funds.
Lastly, there are the geopolitical tensions. The United States has expressed its support for Ukraine in its war against Russia and Israel in its police action in Gaza and its expanded military activity in Lebanon and Iran. Further involvement in these conflict zones will run up the government’s spending and bondholders may ask for higher interest rates to compensate for the risk.
While commenters, academics, and pundits see the above as risks, especially where higher rates lead to a decline in bond values, I see these potential events as opportunities to increase holdings of government bonds in the longer run. Bondholders may both cash out their current holdings and buy lower valued bonds paying the higher yield and enjoy increases in value as risks abate. Or, if they have cash already sitting on the sidelines, may buy additional bonds closer to the topping of interest rates.
Traditional political risks create shorting opportunities.
In my opinion, the most relevant political risks are those that pose an existential threat to government. Those risks wipe out currency traders and bondholders completely. The ultimate political risks are people losing faith in State power; people losing faith in the currency; and people unable to trade the currency’s price movement.
If the State via its executive, legislative, and monetary powers, cannot manage the value of the currency, it will discourage demand for the currency which leads to government funding drying up, dwindling liquidity for financial markets, and a reduction in employment.
As consumers lose faith in the currency, the transmission of monetary value will have to find alternative conduits. For example, while landowners will be able to adjust in part because they can attract margin by leveraging their property, non-asset holding classes will bear the cost shifting as asset holders leave traditional monetary networks and increase trade between themselves replacing traditional human resources with technology. The inability to trade currency movements at that point becomes a foregone conclusion.
Alton Drew
29 October 2024
I assist currency traders in assessing and mitigating legal and political risks. Reach out to me at altondrew@altondrew.com.
Disclaimer: The above post is a thought exercise for informational purposes only, to get your cerebral juices flowing. Please reach out to a trade advisor before making any trade.
Lawyers Write the Bets. Bankers Sell the Bets. 