Global political risk has picked up in recent weeks; firstly there was Scotland, now there are pro-Democracy protests in Hong Kong and a Presidential election in Brazil this weekend. Markets are sensitive to political risk, but it can be difficult to understand what sort of impact political risks can have on asset classes.
We decided to do some analysis on the impact of news stories relating to politics and the performance of domestic asset classes. Here is what we have found.
Scotland:
As you can see in the chart below, as the number of stories about Scottish independence ramped up the closer we got to Election Day and we can see a sharp negative correlation with the pound. This gives us a clear indication that the Scottish independence referendum dampened sentiment towards the pound.
Figure 1:
Source: Bloomberg – these prices do not reflect prices offered by FOREX.com
Hong Kong:
Although the protests are only in their early stages, there are signs that the Hang Seng is deeply impacted by events. This is not surprising, as political risk can weigh heavily on domestic asset prices.
What is more interesting, in our view, is the fact that news stories about Democracy in Hong Kong are having an impact on the Nikkei 225, suggesting that if the anti-China unrest in Hong Kong escalates over the coming months then it could cause contagion to other Asian countries, including Japan.
Figure 2:
Source: Bloomberg – these prices do not reflect prices offered by FOREX.com
Brazil:
This weekend the people of Brazil will head to the polls. With only two days before the vote, incumbent Dilma Rousseff had extended her lead, and polls suggest that she would win re-election in a likely second round runoff, with her main challengers tied for second place.
Tragedy stuck this election when Rousseff’s main opponent was killed in a plane crash. Socialist candidate Eduardo Campos died on August 13th; he was replaced by the popular Marina Silva. Before Campos’s death, Rousseff held a healthy lead, however, afterwards Silva started to overtake the incumbent.
At the same time as Silva took the lead, the iBovespa, Brazil’s main equity index, reached record highs. However, since the start of September Rousseff has staged a comeback in the polls, which has corresponded with a 14% drop in the Brazilian equity index.
The Brazilian real has also been under pressure since Rousseff has taken the lead in the polls, and USDBRL has rallied more than 12%. Although some of this sell off is down to concerns about Fed tightening and the impact that could have on countries like Brazil with large deficits, this analysis also suggests that domestic factors are at play, and the elections are making the declines in the IBOV and BRL worse.
We have found a 60% positive correlation between news stories about Silva’s declining performance in the polls, and USDBRL. The relationship with the Ibovespa, the Brazilian equity index, is also significant, with negative news stories about Marina Silva’s election campaign weighing on the Ibovespa 55% of the time.
Thus, if Dilma Rousseff does win this weekend’s vote then we could see another lurch lower for Brazilian assets. (Please note that FOREX.com does not offer the BRL or IBOV index).
Figure 3: 
Source: Bloomberg, these asset classes are not offered by FOREX.com
Conclusion:
This analysis suggests that elections matter for markets, and they can trigger volatility. There are some major elections in 2015, including the UK general election in May; elections also take place in Spain, Finland, Turkey, Poland and Canada. Thus, political risk could be a major theme for 2015.
Disclaimer: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency or CFD contract. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient.
Any references to historical price movements or levels is informational based on our analysis and we do not represent or warrant that any such movements or levels are likely to reoccur in the future. While the information contained herein was obtained from sources believed to be reliable, the author does not guarantee its accuracy or completeness, nor does the author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.