Markets Bracing for Potential Political Shockwaves

Market Dynamics and Political Intricacies

Yesterday, the Reserve Bank of New Zealand (RBNZ) took a hawkish stance, discussing a potential rate hike and ruling out cuts until the end of 2025. Meanwhile, the UK's inflation figures were concerning, with the Bank of England (BOE) seemingly eager to cut rates as soon as possible. The Federal Reserve's May meeting minutes revealed that several members are prepared to vote for a hike or to maintain rates longer than markets anticipate.

Fortunately for the markets, the AI boom continues to surge, providing a buffer against potential economic instability. However, political developments could still deliver shocks to the market. For instance, there are questions around whether China's President Xi Jinping has altered his stance on housing and consumption. If Beijing were to introduce significant fiscal stimulus, it could limit Western central banks' ability to cut rates, as evidenced by the impact on commodity prices without any Chinese equivalent of the West's Covid stimulus.

Political Developments in the UK

Another potential shock could come from the UK, where a rare summer election is being held. Current polls suggest a potential defeat for the Conservatives. The decision to hold the election now, rather than wait until November, has led to speculation about a potential looming scandal that has prompted this snap election.

Another significant shock could come from the UK's Defence Minister Shapps, who has stated that lethal aid is now, or will soon be, flowing from China to Russia into Ukraine. This could potentially trigger US and EU secondary sanctions. However, it's unclear how much economic damage would be inflicted if these sanctions were to be enforced.

Global Tensions Escalate

Despite these potential shocks, markets may believe that they will pass and that rate cuts can continue. However, this could be a naive assumption, as it would imply that there are no red lines, potentially enabling lethal aid to flow to Russia, strengthening its military position against Ukraine, and leaving Europe and the US unable to respond.

Meanwhile, tensions are escalating elsewhere. Poland's Prime Minister Tusk has suggested that Russia may have started a fire in a Warsaw department store. Russia has also been rehearsing tactical nuclear drills near the Ukraine border. Additionally, Taiwan's new president Lai Ching-te's inaugural address has been seen as provocative by China, which has responded with large-scale military drills around Taiwan.

International Liberal Order Fractures

Further fracturing of the international liberal order has occurred following the International Criminal Court's (ICC) request for arrest warrants for the Israeli prime minister and defence minister, and three leaders of Hamas. This has caused division within the EU, with some countries supporting the ICC and others opposing it. The US has shown bipartisan support for sanctioning the ICC for its recent actions, further complicating the international landscape.

Closing Thoughts

While the AI boom continues to buoy markets, the potential for political shockwaves looms large. The interplay between politics and economics is complex and unpredictable, and the potential for significant disruption is real. What are your thoughts on these developments? Do you think the markets are prepared for potential political shocks? We'd love to hear your thoughts, so please share this article with your friends. And don't forget to sign up for the Daily Briefing, every day at 6pm.