Economic trends clearly point toward higher inflation and interest rates ahead, which will likely make capital markets more volatile. Based on recent headlines, politics seems likely to add fuel to this fire.
Rising inflation and interest rates will probably weigh on the near-term outlook for government bonds. Further down the road, they’re also likely to create headwinds for risk assets, including corporate bonds and equities.
As we see it, geopolitics could magnify the volatility. Among the most noteworthy developments is the escalating tension between Russia and the UK over Russia’s alleged attempt to assassinate a former Soviet agent on British soil. Domestic developments in China and Italy reinforce this notion. And if that wasn’t not enough to set alarm bells ringing, there’s now the intensifying US-China trade dispute to worry about.
Historical Context: Global Integration
To understand the significance of these political events for capital markets, it helps to think of them through the lens of globalization. Over the past 20 years or so, the secular trend toward globalization has supported economic growth and kept inflation low.
Major developments during this time helped power the march toward globalization. Russia made attempts to move beyond the legacy of Soviet communism. China joined the global trading system. And the European Union moved toward greater economic and administrative integration.
Is Globalization Past Its Peak?
Now, globalization appears to have peaked, and may be slipping into reverse. The perception that China, Russia and the West share similar aims and priorities has given way to a fresh appreciation of national political and cultural differences—and the resultant potential for disharmony.
While the Russia-UK uproar is unlikely to have any direct economic impact, it does serve as a reminder of the historical and diplomatic fault lines between Russia and the West, as do the allegations of Russian interference in the 2016 US presidential election.
Recent developments in China are no less significant, with President Xi Jinping removing limits to his term in office. Western commentators are divided. Some see the move as a dictatorial power grab; others see it as Xi’s attempt to create the stability he needs to enact further reforms. Whichever view is correct, China, like Russia, needs to be assessed more on its own terms than through a Western lens.