Political Risks to the U.S. Safe Harbor Premium

Ernie Tedeschi
May 2, 2024

Executive Summary

  1. The US enjoys a safe harbor investment premium—a value that investors place on US safety, soundness and stability.

  2. Even a relatively modest move in risk premia would have profound implications for the US. If the US country risk premium moved to that of the current UK level, after 10 years, real equity wealth per household would be $50,000 lower and real GDP 1% smaller.

  3. The erosion of safe harbor advantages could include more uncertainty and discontinuous risk, higher bond yields, and, ultimately, lower growth.

  4. Country risk analysis is a relative concept. Since the US is conventionally the benchmark for measuring global risk, by construct, US risk is often assumed to be 0 percent.

  5. Along several different dimensions, however, US political risk has risen over the last eight years: we estimate a “shadow” risk premium for the US that implies that US political and institutional risk is more consistent with a country risk premium of 25-35 basis points rather than zero. For context, this is roughly half of the UK’s premium in the immediate aftermath of Brexit.

  6. US shadow political risk was broadly falling over 2006- 2016 and has risen since by around 20-25 basis points. Most of this rise occurred from 2016-20.

  7. There is suggestive evidence that markets are underpricing current US political risk. A gradual pricing in of 25 basis points of shadow risk implies a modestly higher unemployment rate (+0.1 percentage points, or about 200,000 more unemployed workers) and smaller economy (-.25%) after 10 years.

  8. Furthermore, worsening political risk and a precipitating market event could have much more profound implications. For example, a rapid repricing of another 100 basis points of risk—on par with what S&P felt the 2011 debt ceiling crisis equated to—as well as a pullback in foreign direct investment to the US would raise the unemployment rate by around 0.5 percentage points even after a decade and shrink the economy by more than 1%.

A truly catastrophic scenario is difficult to estimate, but a risk shock of 300 basis points—3x the 2011 experience—would shrink average equity wealth per household by more than $200,000 in 2023 dollars and lower annual labor earnings by about $6,000 per worker after a decade.