Economic Insight: Politics and markets will reconnect

War in Ukraine and Syria, rising tensions over North Korea, high policy uncertainty related to Brexit and the Trump presidency, a super-election cycle in Europe … political risk is noticeably higher than it has been in decades. Meanwhile, financial markets are rushing from one high to the next.

Why are markets jubilant despite widespread political gloom? We find that improving economic momentum indicators since mid-2016 largely swamp political worries, while the impact of monetary policy on the risk-return expectations is still dominant.

The disconnect between political uncertainty and market performance is unlikely to last. Monetary stimulus will be withdrawn. The recovery will peak at one point. Assuming that the political risk level will remain high, markets will reconsider, although an immediate sharp reaction looks unlikely.

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