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Investors may continue to trade geopolitics, but the landscape is shifting

  • In the last 12 months, markets have moved away from being extremely sensitive to economic data to focusing on noise coming out of the political realm.
  • Market analysts and economists believe that the geopolitical risk is here to stay and will continue to weigh down global markets.
  • Central banks are starting to turn hawkish, signaling an end to the ultra-loose monetary policy regime.
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Dan Kitwood | Getty Images

Nine years ago when I became a financial journalist, the world was embroiled in post-Lehman Brothers crisis. Financial markets were shaken, investors lost cash while major central banks scrambled to put together contingency plans to limit the spread of the crisis. In these nine years, markets, however, have moved away from being extremely sensitive to economic data to focusing on noise coming out of the political realm.

In the last 12 months, there has been a shift in the way financial markets react to news. Political events such as the U.K.'s vote to leave the European Union, elections in the U.S., France, tensions in the South China Sea and the growing geopolitical standoff between North Korea and the United States have slowly moved the focus away from markets reacting to traditional economic events to politics. The last week at the G-20 summit in Hamburg saw Trump's meeting with his Russian counterpart Vladimir Putin as the biggest focus for global markets.

There have been a number of instances in the past year that have shown geopolitical events driving market performance. While equity and currency markets plummeted after the shocking Brexit results, global equity markets rallied on U.S. President Donald Trump's victory, amid hopes of a fiscal package and less regulation. U.S. stock markets are up almost 20 percent since the U.S. election, while the pan-European Stoxx 600 is up nearly 15 percent.

However, markets seemed to have changed gear in the last few months as risk sentiment turned sour with investors starting to lose faith in Trump's policies and rising geopolitical tensions. The election of French President Emmanuel Macron laid to rest concerns of yet another referendum and the breakup of the European Union. But with market volatility at its lowest in decades and low-yielding traditional assets, investors remain ambiguous on where to put their money.

The CBOE Volatility Index, or VIX, is a key measure of market expectations of a near-term volatility conveyed by S&P 500 stock index option prices. The VIX, widely considered as the best gauge of fear in the market, closed the day after French election on May 9 at 9.77, its lowest level since December 1993. The VIX is currently trading at 11.3 and is down 20 percent year-to-date.

President Donald Trump
Omar Marques | Anadolu Agency | Getty Images
President Donald Trump

Market analysts and economists believe that the geopolitical risk is here to stay and will continue to weigh down global markets. Some analysts, however, have warned that it will take a massive geopolitical event such as a war or accession for market volatility to go back up. But rising tensions between nations ever since Trump came to power has traders and investors concerned and unclear on the next course of action.

Add to that, the changing economic landscape. Central banks are starting to turn hawkish, signaling an end to the ultra-loose monetary policy regime. After years and years of injecting artificial cash into the system, central banks are now signaling a withdrawal.

Quite contrary to the traditional belief that equity and bonds move in opposite direction, the sell-off in bonds points to market nervousness around the scaling back of monetary policy and if it may prove to be risky for the economy.

But while events like a central bank rate decision, inflation data or a shift in monetary policy have traditionally driven markets, it is the big shift to political events that has surprised investors.

The question is if a few years down the line, political risk will continue to be as dominant a theme as it has been in the past year and if investors will trade on the back of an election or a referendum. Or will markets move on to find something else?

(Spriha Srivastava is a lead blog writer on World Markets Live, CNBC's daily market blog. You can follow Spriha on Twitter @spriha)

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