Two events that are being touted to have almost equal economic impact are drawing absolutely opposite reactions from the market which has puzzled many economists and market experts.

While the market in Europe and specifically in the UK have seen regular ups and downs around this month’s vote on Britain leaving the EU, investors appear to be ignoring November’s U.S. presidential election even though these two events may end up being conflated

The reasons behind the gyration of the UK and European markets ahead of the “Brexit” vote and the seemingly non reaction of the US assets to the success of celebrity businessman Donald Trump’s bid for the White House has puzzled fund managers and economists, including Harvard professor and Democrat grandee Lawrence Summers.

It is relatively easy to understand the volatility surrounding a possible redefinition of Britain’s dominant trade and political relationship. The volatility surrounds the uncertainty of how wider European and euro zone markets are likely to suffer from uncertainty over the future of the EU integration itself as well as how the potential hiatus affects the UK economy.

According to International Monetary Fund data, the combined economic output of the EU is 22 percent of global gross domestic product even though Britain is the world’s fifth largest economy.

Many argue that as much market uncertainty as the Brexit referendum should have been created by Republican Trump’s proposals for reshaping the trade and diplomatic relations of the world’s largest economy, his anti-immigration policies and his questions about U.S. Treasury obligations.

Neither a vote for Brexit nor a Trump win are the most likely outcome according to predictions of bookmakers and prediction markets.

However they have accorded a one in three chance of markets reacting to both the events but in reality the markets have reacted to one and not to another.

While for months now, there has been upheavals in the process of sterling, sterling options, UK house building stocks and even government bonds from countries on the euro zone periphery, the U.S. dollar or its derivatives, Treasury bond prices or Wall Street stocks have not seen any perceptible jolt to date from the White House election race.

On the contrary,  the VIX index, or “fear gauge”, of implied volatility on the benchmark S&P remains sedate near its lowest levels of 2016 and the S&P500 index of top U.S. companies hit its highest levels for almost a year this week.

“The markets tend to ignore political risk, which generally has little influence over the real economy. But maybe they should be concerned this time,” Didier Saint-Georges, managing director at French asset manager Carmignac, said.

“Almost inconceivable six months ago, the election by the end of the year of an openly protectionist president inclined to renegotiate federal debt is now plausible in the United States,” Saint-Georges added.

Markets tend to focus on one thing at a time or that November is simply too far away are the two explanations that investors give to the lack of election-related volatility.

But Brexit proved both the explanations wrong.

There was spike in the cost of six-month sterling options expiring just after the expected June voting date as far back as in December. On the other hand even though it crossed the November election date last month, there has been no such surge in six-month dollar volatility.

“Brexit is a bigger risk. American democracy has strong institutions and counter-powers,” Francois Perol, Chairman of France’s second biggest lender BPCE, said last week.

However the blue-chip equity of multi-national corporations across the planet that thrive off smooth cross-border movement of goods could go for a toss and a protracted blow to global trade could be given by a win for both camps, by accident or design. Thus what markets fear most is a confluence of the two events.

(Adapted from Reuters)

Categories: Economy & Finance, Uncategorized