Opinion

Crazy times. Calm markets.

May 11, 2017

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Gillian Tett / US Managing Editor at the Financial Times

Two peculiar things happened in America this week. One of these made headlines: Donald Trump sacked James Comey as head of the Federal Bureau of Investigation, just as the agency intensified investigations into the president's dealings with Russia. It has plunged Washington into a political drama which, at best, could create months of distraction and, at worst, spark a Nixon-style crisis.

The second peculiar event, however, was less noticed: the so-called Vix index of volatility for American stocks sank below 10, to the lowest level seen since 1993, before slightly rebounding.

Yes, you read that correctly. What the Vix now implies is that the outlook for the US economy and markets is more stable and benign than anything seen for 24 years - irrespective of missile threats from North Korea, dangers of China's debt bubble, uncertainty around European populism - and this week's speculation about Mr Trump.

And while the Vix index is not a perfect barometer, since it can be distorted by opaque trades, what is equally striking is that other market indicators also signal calm. US equity prices are high and have not budged in response to these dramas. Credit markets are frothy. Indeed, confidence in future stability seems so high that Bridgewater, the hedge fund, is telling clients it is seeing an explosion in the "carry trade", or a situation where investors borrow cheaply to invest in riskier assets.

How to explain this juxtaposition? One, cynical, explanation might be that investors, unlike journalists, simply don't care about politics. The US economy has been expanding for eight years and groups such as the International Monetary Fund predict healthy global growth this year. And though the Federal Reserve is tightening, the Bank of Japan and European Central Bank are still injecting huge liquidity into the market. This, rather than any Trump reform agenda, keeps supporting asset prices; or so the argument goes.

A second explanation, however, is that politics does matter but investors think that the present political administration has two faces. One of these faces is dominated by the president as reality-television star, who grabbed the headlines this week by telling Mr Comey in effect, "You're Fired!", and subsequently embarked on a Twitter rage against his opponents.

The second face is the sensible part of his senior team, which includes respected figures such as Rex Tillerson, Lieutenant General HR McMaster and General James Mattis (on the foreign policy side) and Gary Cohn, Steven Mnuchin and Wilbur Ross (on economic policy). These men appear to embrace a sober foreign policy stance and Reagan-style agenda of tax cuts, infrastructure plans and deregulation. It is the latter that has investors excited, since they think the "sensible" face will outlive the crazy dramas.

Investors know that there is also a danger that Mr Trump's Russia scandals prove so distracting that Congress never gets a chance to discuss tax reform or healthcare. But optimists around the White House insist that work on the reform agenda is proceeding apace; some believe that the scandals might make congressional Republicans more - not less - determined to pass some economic reform bills; after all, they will need some good news to campaign on in the next midterm elections.

There is, however, a third, more alarming, way to interpret the Vix: investors are dangerously complacent about (geo) political risks. More specifically, one way to frame the situation is that markets have stealthily slipped into a "normalisation of deviance" pattern, to use the phrase coined by sociologist Diane Vaughan: so many political boundaries and precedents have been broken that investors have lost perspective on events, because the bizarre seems almost normal.

After all, Mr Comey's removal is no usual political blood-letting: it overturns the time-honoured principle that presidents do not fire the people investigating them, or attack independent bodies. If this is undermined, America's political economy looks more like an emerging market than western democracy: rule of law is supposed to be a bedrock of America's political culture (and its capital markets).

Most senior Republicans would dismiss this interpretation of events as alarmist. I still think that there is a reasonable chance that the antics of Trump-the-Reality-Television-President will be reined in by the judiciary and more sensible aides. But the longer the Vix stays low, the more peculiar the juxtaposition between markets and politics seems to be; and, of course, the greater the risk of a future snapback.


Copyright The Financial Times Limited 2017