Political developments in Japan and France have brought more
volatility to sovereign debt markets. Our Global Economist
Arunima Sinha highlights the risks investors need to watch out
for.
Read more insights from Morgan Stanley.
----- Transcript -----
Political developments in Japan and France have brought more
volatility to sovereign debt markets. Our Global Economist
Arunima Sinha highlights the risks investors need to watch out
for.
Arunima Sinha: Welcome to Thoughts on the
Market. I'm Arunima Sinha, from Morgan Stanley's Global and U.S.
Economics teams.
Today, I'm going to talk about sovereign debt outlooks and
elections around the world.
It's Wednesday, October 15th at 10am in New York.
Last week we wrote about the deterioration of sovereign debt and
fiscal outlooks; and right on cue, real life served up a
scenario. Elections in Japan and another political upheaval in
France drove a reaction in long-end interest rates with fiscal
outlooks becoming part of the political narrative. Though markets
have largely stabilized now, the volatility should keep the topic
of debt and fiscal outlooks on stage.
In Japan, the ruling Liberal Democratic Party, the LDP, elected
Sanae Takaichi as its new leader in something of a surprise to
markets. Takaichi's election sets the stage for the first female
prime minister of Japan since the cabinet system was established
in 1885.
That outcome is not assured, however. And recent news suggests
that the final decision is a few weeks away. The landmark
movement in Japanese post-war politics, in some ways further
solidifies the changing tides in the Japanese political economy.
Markets have positioned for Takaichi to further the reflation
trade in Japan and further support the nominal growth revival.
The Japanese curve twists steepened sharply as Tokyo markets
reopened with the long-end selling off by 14 basis points amid
intensifying fiscal concerns and the unwinding of pre-election
flattener positions. Specifically, expectations appear to be
aligning for a more activist fiscal agenda – relief measures
against inflation, bolstered investment in economic security and
supply chains, and stepped-up commitments to food security.
Our strategists expect that sectors poised to benefit will
include high tech exporters, defense and security names, and
infrastructure and energy firms, as capital is likely to rotate
towards these areas. Though, as our economists cautioned, the
lack of a clear legislative maturity may hamper efforts for
outright reorientation of fiscal policy.
Meanwhile, we expect the implications for monetary policy to be
limited. Our reading is that Taikaichi Sanae is not strongly
opposed to Bank of Japan Governor Ueda’s cautious stance reducing
expectations for near term hikes. But we also reiterate that a
hike late this year remains a possibility, particularly as the
yen weakens.
Economically, our baseline call has been supported by the
election outcome given we did not expect the BoJ to raise rates
in the near future. Indeed, market expectations of an increase in
interest rates have been priced out for the next meeting.
France is the other economy that saw long-end rates react to
political shifts since we published our debt sustainability
analysis. PM Lecornu's resignation was far quicker than markets
expected, especially given the fact that he was only in office
for a matter of weeks.
A clear majority in the current parliament remains elusive
pointing to continued gridlock, and ultimately snap elections
remain a possibility for the next weeks or months. At the heart
of the political uncertainty is division about how to proceed
with fiscal consolidation against a moving target of widening
deficits.
The lack of fiscal consolidation in France has been a topic for
many years. Though the ECB provides an implicit backstop against
disruptive widening of OAT spreads through the TPI, our Europe
economists view the activation of TPI as unlikely. As the spread
widening has been driven by concerns around France's fiscal
sustainability, a factor that is likely seen as reflecting
fundamentals.
In our rather mechanical projections on debt, we highlighted
markets would ultimately determine what is and is not
sustainable. These political events are the type of catalyst to
watch for.
So far, the risks have been contained, but we have a clear
message that complacency could become costly at any time. With
the deterioration in debt and fiscal fundamentals, we suspect
there will be more risks ahead.
Thanks for listening. If you enjoy the show, please leave us a
review wherever you listen and share Thoughts on the Market with
a friend or colleague today.
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