Friday, September 19, 2014

Geopolitics v. Markets

Global Economics Monthly: September 2014 report published by the prestigious Council on Foreign Relations (CFR) provides an interesting analysis on the connection between geopolitical conditions and financial markets.

Generally, market watchers scan the political landscape and look for developments that might affect the world of finance. In turn, the harvested data is used to develop market predictions and determine the current volatility levels.

However, this connection is not always so clear-cut. The crises in Ukraine and current turmoil in the Middle East are striking testimonies to this reality. The spillover effects are different for each country. For instance, China has economic buffers that protect it from many existential shocks.

The report goes on to say that market investors might overestimate the impact of political developments on the financial markets. The cause and effect factors are not always clear and the implications of political changes mostly depend on the country’s connectedness to the global markets.

So, what are some of the metrics we can look at?

The central bank policy plays a major in shaping the economic realities. For instance, the low interest rate stimulates economic growth and provides incentives to open new businesses and take risks. The author mentions that the federal interest rates are expected to go up in mid-2015.

One of the trusted metrics that is used to measure market volatility is the VIX index. Current figures show that market volatility has risen, but continues to remain at historically low levels. This news provides some confidence for market traders.

On the political landscape, one can look at the Eurozone, which is plagued with systemic problems. The lack of economic resilience has made it vulnerable to external crises and shocks. Furthermore, due to Europe’s connectivity with the rest of the world, European problems are world’s problems.

Therefore, market players should look to Europe and check the VIX index to tailor their moves in the game. 

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