Macroscope | How Trump’s reckless policies could trigger a financial crisis

How much does politics matter to financial markets? Many investors believe political risk has a stronger bearing on sentiment towards developing economies because of weaker standards of governance. The sharp declines in asset prices in Indonesia and Turkey over the past week amid concerns about the politicisation of policy suggest they might be right.

Yet since the eruption of the 2008 global financial crisis, it was advanced economies that caused the biggest political shocks. The euro zone debt crisis, Britain’s decision to vote to leave the European Union and US President Donald Trump’s victory in the 2016 election forced investors to rethink their asset allocation strategies and their perceptions of sovereign risk more broadly.

Ever since the US was stripped of its coveted triple-A credit rating by Standard & Poor’s in 2011 because of a deterioration in “the effectiveness, stability and predictability of American policymaking”, concerns about the institutional underpinnings of the US as a safe haven have intensified.

While the chaos during Trump’s first term in office heightened fears about threats to US democracy and the economy, many investors believed Trump’s bark was worse than his bite. This was partly because they thought checks on his agenda were robust enough to prevent a full-blown constitutional crisis.

Although many fund managers still believe the country’s unique strengths – the US dollar remains the world’s pre-eminent reserve currency while the US Treasury bond market is the bedrock of the global financial system – limit the damage a second Trump presidency could inflict on the US economy and markets, investors have belatedly realised that the threats posed by Trump 2.0 are more acute.

Even those who predicted Trump’s return to the White House would put US democracy and the economy at much greater risk have been taken aback by the speed and ferocity of the administration’s assault on the global trading system and, in the words of the Brookings Institution, its “efforts to peel back democracy and its guard rails”.