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Market Extra: Investors ignore Afghanistan, but risk levels are on the rise

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Global financial markets have been largely unmoved by developments in Afghanistan, but the chaotic U.S. exit from the country is heightening underlying geopolitical risks, and, according to some analysts, potentially clouding the outlook for President Joe Biden’s legislative agenda.

“When it comes to markets, there continues to be basically no day-to-day relationship between U.S. geopolitical risks and equity markets” as a result of the situation in Afghanistan, said Mark Y. Rosenberg, chief executive officer of GeoQuant, a research firm that analyzes geopolitical risk.

But the outside risk of a terrorist attack or other major geopolitical incident has risen, according to GeoQuant’s data-based metrics.

“It does make the ever present fat-tail risk of a major terrorist attack on the U.S. fatter,” Rosenberg said, in a phone interview.

Put simply, tail risk refers to the prospect of an event that’s unlikely but would trigger a significantly outsize move in financial markets. Some financial professionals define a tail-risk event as one that produces market moves that are three standard deviations beyond the mean.

The Taliban had harbored al Qaeda before the terrorist organization’s Sept. 11, 2001, attacks on the U.S. which prompted the U.S. invasion of Afghanistan and the toppling of the Taliban. Reports have said the Taliban freed al Qaeda fighters from prisons as they took control of the country this month, according to The Wall Street Journal.

With no U.S. military bases in Afghanistan, U.S. officials and security experts fear it will be more difficult to monitor potential terrorist threats emanating from the country.

United Nations officials have said that al Qaeda operations are still present in some areas, the Journal reported, while U.S. intelligence assessments said the organization could reconstitute itself in Afghanistan 18 months to two years after a U.S. withdrawal. U.S. Secretary of State Antony Blinken has said the capacity of al Qaeda members in Afghanistan to attack the U.S. has been diminished.

But would the risk picture be any different had the U.S. exit proceeded in an orderly fashion, in keeping with the Biden administration’s timetable? Rosenberg said that had the Afghan army been able to better withstand the Taliban assault, “it’s reasonable to assume those forces would have been a better check on terrorist activity from Afghanistan. So at the very least, the perception of that risk would have been blunted,” he said.

Read: Will Taliban takeover of Afghanistan tarnish the U.S. dollar and other assets?

The Biden administration was discussing with allies a potential extension of the Aug. 31 deadline for withdrawing from Afghanistan as they attempt to evacuate thousands of people from the country, The Wall Street Journal reported.

U.S. stocks rose Monday, with the Nasdaq Composite
COMP,
+0.47%

finishing at a record and the Dow Jones Industrial Average
DJIA,
+0.13%

and S&P 500
SPX,
+0.25%

logging solid gains. The dollar lost ground Monday, but rallied last week, with the ICE U.S. Dollar Index
DXY,
-0.01%
,
a measure of the currency against a basket of six major rivals, hitting a nine-month high.

Stocks traded slightly higher Tuesday morning, with the S&P 500 index trading above its recor close from Aug. 16.

While shifts in threat perceptions are not translating into adverse daily moves for asset prices, some analysts contend that political blowback from the Afghanistan situation could have consequences for the U.S. economy and markets.

“It is unclear how the perceived incompetence of the Afghanistan exit may impact the bipartisan infrastructure bill and the social infrastructure bill this fall,” wrote Tavis McCourt, institutional equity strategist at Raymond James, in a Sunday note.

“Passage will increase expectations for growth/inflation, while a political defeat will create another arrow in the quiver of those betting on growth disappointment in 2021/2022 and a quick return to disinflation,” he wrote.

House Democrats deadlocked Monday night, with moderates resisting an effort by party leaders to tie together a $1 trillion package of infrastructure spending, which passed the Senate with a bipartisan majority, and a $3.5 trillion package of social spending supported by Democrats.

See: Moderate Democrats bring House to standstill in Biden budget clash

Some commentators also see the Afghanistan fallout increasing the likelihood that Biden will reappoint Jerome Powell, a Republican, to a second term as chairman of the Federal Reserve. Speculation had been rising that Biden, in a move that would satisfy progressive Democrats, would instead nominate Fed Gov. Lael Brainard to the post.

Economist Tim Duy, a prominent Fed watcher, has argued that Biden would now be reluctant to pick a fight with Senate Republicans.

See: The real significance of Afghanistan to markets may be how it’s shaped Fed succession battle

GeoQuant’s Rosenberg said that while the Afghanistan chaos likely would make Biden less eager for a battle over the Fed chairmanship, Powell’s reappointment had already looked likely.

As far as the legislative agenda is concerned, the analyst argued that bipartisan support for spending on infrastructure won’t be affected by developments around Afghanistan, making it likely that some sort of package wins approval.

More important, the situation reinforces the historic trend toward anti-incumbent voting in midterm elections, giving Republicans more ammunition in their bid to retake control of Congress next year, he said.

Steve Goldstein contributed reporting.

Project Syndicate: The future of global growth is in peril

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