The Politics of Financial Volatility

LONDON – Twenty-four years ago, in the midst of an ugly US presidential campaign, Bill Clinton’s campaign manager neatly summed up his candidate’s message: “It’s the economy, stupid.” Today, as investors struggle to understand what is driving extreme volatility in the financial markets, there is an equally pithy explanation: It’s the stupid politics.

Central bank policies have moved from supporting the markets to potentially destabilizing them. Now markets are turning to structural reform and fiscal policy for assistance. In this light, current price movements should be viewed through the spectrum of geopolitics. And it is not a nice view.

Nowhere is this more evident than in the oil markets, where prices have collapsed, with both Brent and Crude now hovering around the $30-per-barrel level. The extent of oil’s fall, and consequent deflationary fears, is cited as a major factor behind overall market turmoil. In January, the correlation between crude oil prices and the S&P 500 reached the highest level since 1990.

It has become increasingly clear that supply dynamics, rather than falling demand, explain the drop from $110/barrel since the summer of 2014. The shift to competitive pricing implied by the breakdown of Saudi Arabia’s monopoly power, together with OPEC’s desire to counter the threat from US shale energy, drove the first downward move. Likewise, the recent lifting of sanctions on Iran, and the resulting increase in global oil supply, prompted a further 9% price drop over a matter of days.