Debt markets are facing political risk at an extraordinary scale this year — and, for the first time for years, they do not have central bank largesse to use as a shield. Expect sharp bouts of chaos.
In 2024, about half of the world’s population will head to the polls, with at least 63 countries holding national elections and the European Union holding an election for the European Parliament. More voters than ever before will be asked to cast ballots.
Not all elections are equal, of course. It is unimaginable that Vladimir Putin will not preside over Russia after March 17, for example. Elections in Africa could affect emerging market bonds but are unlikely to have wider ramifications for the debt markets.
Other elections hold far greater weight and risk to the global capital markets. The US presidential election in November looks likely to pit incumbent Joe Biden against the man he replaced, Donald Trump.
Trump’s first term was considered by many an anomaly, created by angry protest voters who wanted change. But if the man who was impeached for inciting an insurrection, who slashed environmental regulations, withdrew from multiple multilateral agreements and entered into a trade dispute with China via Twitter (now X.com) is voted back in this year, the US public will know exactly what they are choosing to represent them at home and abroad. The rest of the world will need to adjust accordingly to a superpower that is less willing to befriend, more inward-looking and more volatile.
No money shield equipped
There is another significant difference between Trump’s first term and his potential second. In the summer of 2016, the US Federal Reserve had printed $12.3tr of money and $10tr of bonds around the world paid negative yields. In the first six months of 2016 alone, the Fed bought $2.45tr of domestic debt.
When political outlier Trump shocked the world and was voted into the biggest seat in politics, yields rose. Despite all the predictions of a market meltdown if Trump won, investors appeared to rejoice, pricing in deregulation, higher growth and hence higher interest rates. The 10 year Treasury was trading at 1.78% at the end of October 2016 and hit 2.36% at the end of November.
But a 58bp rise on such a big political risk event now seems almost quaint, in the present world where central banks have cut off the money to debt markets.
Between March 2023 and the end of October, yields rose by 162bp. It was not unusual last year for rates to move by more than 10bp in a day, playing havoc with important aspects of issuance, such as defining fair value.
The first major indication of how susceptible debt markets are to political risk will come this month, when Taiwan heads to the polls for a presidential and general election on January 13. The outcome could further stress Taiwan’s already strained relationship with China.
Even bankers in seemingly unrelated markets, such as European high grade corporate bonds, are preparing for spreads to widen sharply in the wake of Taiwan’s vote.
For the debt markets, the political risk this year will magnify trends that were already taking shape last year. Issuance windows will become shorter and even more sharply defined.
This means more borrowers cramming into fewer days, and much more risk of bringing a deal on a bad day and seeing it wither. It is unlikely to be an easy time for anyone.