Political risk factor becomes key to market volatility

Politics has been at the heart of some of the sharpest market moves in early 2010, with much money to be made or lost as investors call developments right or wrong. It is a trend that looks likely to last.

It is not that political risk itself is higher. The key events in the 2008 crash and following market recovery — the decision not to bail out Lehman Brothers, the London G20 meeting, the decisions to launch stimulus packages — were essentially political moments with profound market impact.

“It's more that it is affecting markets in a different way,” said Alastair Newton, managing director and political analyst for Nomura.

Essentially, while in 2008-9 a few political decisions helped set the tone for markets for months at a time, now political newsflow looks to be an increasingly important factor driving shorter term moves as well as longer-term trends.

Valuing banking stocks has become impossible without taking a view on how far U.S. President Barack Obama will go as he takes on Wall Street with an eye to mid-term elections in the aftermath of the Democrats' Senate defeat in Massachusetts.

Obama's January bank reform announcement knocked major U.S. indices down some 4 percent over two days. Market players will be nervously watching policymakers in the run-up to mid-term elections, with the uncertainty meaning investors will demand a higher risk premium and push prices lower.

Investors nervous over whether the Eurozone's most indebted economies will default on their debts or be forced out of the euro must assess the ability of governments to force through cuts in the face of potential unrest and political strains.

They must also look at the political viability of rescue from the European Union or the International Monetary Fund if one of the so-called PIIGS — Portugal, Italy, Ireland, Greece or Spain — are pushed to the edge of collapse.

As Britain heads towards a parliamentary election that must be held before June, the pound looks set to be knocked up and down by opinion polls as markets worry a hung parliament could paralyse policymaking at the wrong moment.

Most analysts say they believe the prospect of a Western European default or break in the single currency remains unlikely, but expect assets such as Greek, Spanish and Portuguese bonds and credit default swaps to be buffeted back and forth by political winds.

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