Why haven’t geopolitical headlines rattled the markets?
by Kristina Hooper, Global Market Strategist, Invesco Ltd., Invesco Canada
Geopolitical risk has risen in many areas of the world, and we saw several key issues escalate last week. When I travel and meet with clients, I’m increasingly asked why markets don’t reflect these growing risks. Part of the answer is that markets have simply become somewhat immune to it. However, I also believe that two key factors have helped cushion capital markets from the impact of geopolitical risk: accommodative monetary policy and the growing global economy. In this week’s commentary, I discuss all of these competing market forces.
Geopolitical issues worsen
North Korea. First and foremost, the situation in North Korea continues to escalate. Last week, a North Korean spokesperson said that warnings of a possible nuclear test over the Pacific Ocean should be taken literally. Then Japan’s defense minister announced that the threat from North Korea had reached a “critical and imminent level.” Over the past weekend, U.S. Secretary of Defense James Mattis, fresh from a visit to South Korea, warned that the threat of a nuclear attack by North Korea has increased, which has brought a “new urgency” to cooperation between the U.S., South Korea and other allies.
Mattis made it clear that diplomacy remains the “preferred course of action.” However, he also made it clear that the U.S. is committed to defending itself and its allies from North Korean aggression, explaining that, “Any use of nuclear weapons by the North will be met with a massive military response, effective and overwhelming.” It seems that Mattis’ comments were directed at China – while the U.S., South Korea and Japan have increased their sanctions on North Korea, they believe they have not been as effective because China continues to quietly allow some trade with North Korea. The preferred course of action, diplomacy, hinges on China’s cooperation. With U.S. President Donald Trump visiting Asia this week, I would expect a “carrot and stick” approach to winning China’s support for increased sanctions – and adherence to those sanctions – against North Korea by threatening trade protectionism while offering enormous praise for Chinese President Xi Jinping’s growing political strength and consolidation of power.
Spain. The situation turned from bad to worse in Spain last week, as Spanish Prime Minister Mariano Rajoy spurned Catalonia’s request to negotiate the terms of greater independence. In response, Catalonia – which until then seemed reluctant to attempt an actual secession – voted to establish an independent government. This in turn was met with Rajoy’s dissolution of the Catalonian parliament. We may soon see more disruption, as Spain attempts to enforce direct rule and replace Catalonian officials with pro-Spanish-unity administration officials. However, markets have shrugged this off – the yield on the 10-year Spanish government bond rose, but then fell back. Spanish stocks, as represented by the Spanish IBEX 35 Index, have actually risen in recent days.