The proliferation of weapons of mass destruction, terrorism and a newly emboldened Russia shows us the world is an unsettled place but financial markets seem to be calm. Most of the recent gains in markets have happened despite possible Russian interference in the US Presidential election; North Korean missile launches and various other potentially alarming events.
This is not unusual behaviour for markets. Since the Second World War, the US S&P 500 has fallen by an average 3.5% in response to shocks from the Cuban missile crisis to the 2014 Crimean conflict. Typically markets regained their losses within an average of 5 days.
The huge liquidity from central banks has helped maintain calm. The knowledge that strong institutions, such as central banks, will intervene in times of crisis, comforts investors, as happened when interest rates were cut in the wake of the 9/11 terrorist attacks.
Energy markets have also helped. Oil prices are now far less sensitive to events in the Middle East and other volatile oil-producing countries and regions. The shale revolution has transformed global oil markets in the past 10 years, reversing a long decline in US output, challenging OPEC’s influence and helping to trigger a sharp drop in oil prices since 2014.
The rise of populism is a worry for 2018. Previously, broadly centrist governments responded in similar ways to economic and political events. The rise of populism appears to have broken that consensus. Populist governments tend to have narrower, nationalist interests that are not well served through international cooperation. Examples are Brexit and Donald Trump’s attacks on the World Bank, various Free Trade Agreements and indeed the World Trade Organisation. In the current environment, institutions such as the G20, tasked with finding international solutions to international problems, will struggle.
With weaker inflation than predicted, markets are questioning central banks’ ability to manage their economies and deal with future shocks. If their policies do unsettle financial markets, they could become convenient political scapegoats for the like of Donal Trump.
Politics is not the be all and end all, but it may have a big influence in 2018.