Fighting Makes The Finance World Go Round

Fighting Makes The Finance World Go Round

over 3 years ago3 mins

Financial markets are truly global – a fact illustrated again recently by investors’ responses to geopolitical tensions and their effects on the world’s largest economies and companies.

🕰 Recap

  • Back in July, investors expected a clean sweep for the Democratic Party in November’s US elections
  • Data out this month showed Chinese and US manufacturing roaring back to life despite renewed trade tussles
  • Fresh disagreements between the UK and European Union (EU) this week threatened to derail their own trade deal, while US policy was blamed for nixing an intercontinental company takeover

✍️ Connecting The Dots

Global politics undeniably – and often frustratingly – affect financial markets, with wide-ranging ramifications for stocks, bonds, currencies, and beyond. The US elections are the biggest political event on the planet this year, and while specialist prediction markets suggest the Democrats will win control of the White House, Senate, and House of Representatives, there’s still high implied stock volatility after the election date: investors aren’t expecting the result to be quite so straightforward.

Europe-focused investors, meanwhile, have been agonizing over the UK and EU’s still uncertain future relationship. At a pinch, they’d probably invest in Europe over the UK: while the EU eventually agreed a cohesive economic response to coronavirus that’s set it on a solid footing to tackle the pandemic, the UK’s deepest-ever economic decline could have a heavier hangover. Indeed, analysts predict that by March the Bank of England will be forced to cut interest rates further to encourage sustained spending among Brits.

And then there are trade wars. The US and China remain at loggerheads over things like tech and telecoms (including TikTok), while the US and Europe are still beefing over tariffs on leather and gin; given enough time, meat will probably be back on the menu too. In fact, emotions have run so raw that French luxury heavyweight LVMH this week pulled out of its $16 billion deal to breakfast on all-American jeweler Tiffany’s.

🥡 Takeaways

With so much still up in the air, it’s perhaps no surprise that many investors have turned to stock “options” in a bid to hedge the effects of any unexpected happenings. A small fee lets you purchase the right to buy or sell investments at a pre-agreed cost when they hit a set “strike” price. Investors may buy a “call” (i.e. the right to buy) with a higher strike price as well as a separate “put” (i.e. the right to sell) at a lower one – potentially benefiting whether the underlying investment’s price rises, falls, or ends up back where it began. Still, that’s harder than it sounds…

Currencies’ values relative to one another capture an economy’s growth prospects, interest rates, and inflation – and might therefore be considered financial markets’ truth serum. Here’s an example: the relationship between inflation and exchange rates is based on an economic model called “relative purchasing power parity” (relative PPP). PPP assumes that the same goods should be the same price in every economy, and reflected in their exchange rates – so if a $200 item costs £100, the exchange rate would be $2 to every £1. But if annual inflation is 10% in the US and 0% in the UK, that item will cost $220 a year later, making the exchange rate $2.20 per £1. An economy with high inflation should therefore see its currency weaken versus that of a place where inflation is lower.

🎯 Also On Our Radar

Luxury exercise equipment maker Peloton’s stock rose more than 10% on Friday after a stronger-than-expected earnings update. Peloton’s announcement suggests that short-term changes in consumer behavior in response to the pandemic could become more long-term – or indeed permanent, if people find suitable at-home alternatives to everyday activities like gym classes.

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