THE INFLUENCE OF "GEOECONOMICS" IS GROWING / THE FINANCIAL TIMES MARKETS INSIGHT

The influence of ‘geoeconomics’ is growing

Financial anomalies are another sign of how political factors are shaping economic policies and markets

Mohamed El-Erian

The appointment of Stephen Miran to the Federal Reserve board is seen by some as establishing a de facto second chair for the central bank © Bloomberg

A fascinating tug of war is unfolding in the US government bond market that is an indicator of a broader trend — the spreading influence of “geoeconomics”.

Going into September, many traders and analysts were comfortable with the notion that the US government bond yield curve would steepen — that is, longer-dated yields would rise faster than shorter-dated ones to take into account the greater risk of holding bonds for more time.

After all, US debt and deficits were high, with no immediate prospects for a reversal. 

Inflation was stuck above the Federal Reserve’s target and was likely to edge higher. 

And there were signs that foreign investors were looking to gradually reduce their historical “overweight” holdings in US Treasuries.

But this consensus view has been challenged by comments from government officials that they wished “to bend the curve” — that is, to lower rates well beyond the very short maturities that the Fed can control directly in order to make mortgages more affordable, a key political objective of the Trump administration. 

This could be pursued through the Treasury’s liability management operations or the various tools that the Fed has deployed in the past (such as “Operation Twist”, which sold short-term debt and bought longer-term paper, and straight asset purchases).

We will see what prevails but the potential influence of non-commercial factors in determining the shape of the yield curve seems consequential at a time when there have been worries over the central bank’s political independence. 

The appointment of economist Stephen Miran to the Federal Reserve board is viewed by some as establishing a de facto second chair for the central bank, given that he is seen by many as representing the views of the successor to current Chair Jay Powell, whoever that will be. 

(Miran holds the Fed position while on leave from his position as chair of the US Council of Economic Advisers).

The tug of war also comes at time when many political forces are influencing economic policies more. 

Other examples this year alone include the increased weaponisation of trade and finance and their use to pressure both allies and adversaries on non-economic issues; the spread of industrial policy to achieve aims such as securing crucial supply chains; and the use of export controls on advanced technology to restrict a rival’s military and economic development. 

This trend is not isolated to the US; increasingly, it is happening globally.

It is evidence of how domestic political and geopolitical objectives are influencing economic policies more. 

And that is a dramatic break from the many decades in which economics was a determining influence on domestic politics and geopolitics — a time when two conventional wisdoms anchored the global economy. 

The first was the “Washington Consensus” stressing internal deregulation, trade liberalisation, fiscal responsibility, privatisation, and tax reform. 

The second was globalisation, or the ever closer integration of trade and capital flows.

Both operated on the assumption that free markets and economic efficiency would naturally lead to prosperity for all. 

They were built on a bedrock of economic logic, where politics and national security were considered secondary rather than central drivers. 

However, their effectiveness was undermined by insufficient attention to inequalities and other vulnerabilities they could create.

The growing influence of geoeconomics makes for a more volatile environment for policymakers, business and market participants with a much wider set of potential outcomes to consider.

Just witness what has been happening in financial markets over this year. 

When else have we witnessed both “risk-on” assets (stocks) and “risk-off” ones (bonds) simultaneously post one record price level after the other? 

This apparent paradox is not easily understood except through a geoeconomic lens. 

It is one of several breakdowns in traditional correlations, which relied on a clear separation between market forces and political actions.

It’s a more complex world, with some key rules of the game in markets and economics being rewritten in real time. 

Corporate leaders and investors need to integrate geopolitical and domestic political factors much more into strategies, recognising that the range of potential outcomes is a lot larger and stranger. 

After all, as a colleague quipped last week, the only certain thing these days in uncertainty — and even that tends to get more unusual by the day.

The writer is president of Queens’ College, Cambridge, and an adviser to Allianz and Gramercy