US election implications: The economy, FX and financial markets

20 Oct 2020

George Brown, Jonathan Pryor, John Wyn-Evans

With two weeks to go, Americans are facing a pivotal election that could transform the leadership of the US and its relations with the world. The coronavirus pandemic has already upended the campaign, and the new president faces challenges from climate change and US-China tensions.

Investec experts explore the main scenarios for US politics beyond the election and the potential implications for the global economy, currencies and financial markets.

 

 

The implications for the economy

George Brown, economist, Investec

 
Victory for President Donald Trump would secure him a mandate for another four years of his "America First" agenda. A key plank of this has included reshoring manufacturing jobs after decades of deindustrialisation, which he has sought to achieve by renegotiating the North American Free Trade Agreement (NAFTA) and hiking tariffs on imports from China. If re-elected, Trump can be expected to remain belligerent with Beijing while also pursuing trade disputes with others, such as the European Union.
 
While this protectionist stance could well weigh on growth via higher tariffs and policy uncertainty, it may also be offset by a more accommodative tax environment. Trump has pledged to make permanent the temporary tax rate cuts and other provisions in his 2017 overhaul of the tax code. Other proposals include giving tax credits to companies which move their overseas operations back to the US and cutting the top rate of capital gains tax from 23.8% to as low as 15%. A further boost to the economy could come through higher infrastructure investment, with Trump favouring increased spending on roads, bridges and airports.
 
However, he will struggle to deliver on his tax and infrastructure commitments without the full control of Congress. The currently Republican-controlled Senate could change hands – it is almost too close to call. In contrast, House of Representatives looks likely to remain in the Democrats’ hands in the upcoming election. Recent unsuccessful efforts to pass further coronavirus relief have served to underscore the importance of having Congress on side, with a compromise proving elusive.
 
Overall, it seems that a victory for Trump is likely to be a continuation of the status quo rather than a return to the disruptiveness that characterised the first two years of his presidency, although we would expect him to up the fighting talk on trade disputes pretty fast after any victory.
"Other revenue-raising measures planned by Biden include the introduction of a minimum tax for US-domiciled companies and a new top capital gains rate of 39.6% for households with incomes exceeding $1 million."
In the other Democratic camp, former Vice President Joe Biden has pledged to “Build Back Better” from the economic devastation wreaked by the pandemic if elected. This would include spending some $2 trillion over the next four years on infrastructure improvements, constructing sustainable homes and creating clean energy jobs.
15%
President Trump proposes cutting the top federal tax rate on long-term capital gains from 23.8% to as low as 15% if elected for a second term
But to help fund this, Biden has set his sights on reversing a number of the tax cuts enacted by the incumbent administration in 2017. Although he intends to codify the tax cuts for households earning less than $400,000, it is his intention to raise the marginal tax rate on the highest earners from 37% to 39.6%. He has also said that he will partly reverse the lowering of the corporate tax rate from 35% to 21% by hiking it to 28%.
 
Other revenue-raising measures planned by Biden include the introduction of a minimum tax for US-domiciled companies and a new top capital gains rate of 39.6% for households with incomes exceeding $1 million. But achieving this will depend on whether the Democrats can secure a majority in the Senate which, unlike the House of Representatives, is a toss-up. If this proves elusive, Biden is likely to face much of the gridlock faced by Trump in the last couple of years.
 
Other policies set out by Biden similarly stand in stark contrast to those of his Republican challenger, but a rare common goal shared by the two candidates is boosting domestic manufacturing. However, a key difference is that Biden has shown little appetite in pursuing this overwhelmingly through tariff action and as such may well opt for a more collaborative global stance. Also note that he has also signalled a more cautious approach to re-opening the economy amidst the pandemic, although he has also proposed trillions in spending to create new jobs as opposed to the one-off stimulus and payroll tax relief that has been pursued by Trump.
$2 trillion
Mr Biden has pledged to spend $2 trillion over the next four years on infrastructure, sustainable homes and clean energy if elected
Trump vs Biden policies

 

 

The implications for foreign exchange

Jonathan Pryor, Head of Corporate FX, Investec

Trump and the US dollar have had somewhat of a tempestuous relationship due to his intense views on trade and US interest rates, both of which have threatened the traditional Republican stance on these matters. If he is re-elected, the market and the dollar will at least know what they’re in for, even though with the timing of the election is obviously in the midst of an economic crisis that has hit the US extremely hard. Much of the next four years will be about creating confidence that the country can bounce back economically and socially.
 
The first televised debate between Trump and Biden may provide somewhat of a taster of what’s to come for the Greenback. As Biden seemingly triumphed during the debate, the dollar weakened as this is generally perceived as positive for global harmony in the short term, particularly against the Chinese yuan. It’s difficult to picture right now, but before the pandemic, the key topics for the dollar when it came to the election would have been ongoing economic stimulus and trade wars.
 
Based on the notion that Trump has strong and unflinching views on both of these things, it can be argued that one would cancel the other in a Trump administration – the dollar strength created from potential trade wars would be balanced by weakness through pumping the economy with liquidity and supporting risk.
 
In a pandemic world, the ability to maintain stimulus at a current rate is very unlikely, while we know general economic conditions worldwide continue to be grave. That all leads to the likelihood that the dollar would strengthen in the first half of a new Trump administration as investors seek safety.
"Much of the next four years will be about creating confidence that the country can bounce back economically and socially."
But if we go by the latest polls, which show Biden in the lead, the result is likely to be negative for the dollar. If the polls prove to be correct and Biden wins – assuming this will signal significant fiscal stimulus by the Democrats – the global economy will receive a welcome injection of liquidity and growth that should ignite risk markets and therefore will see the US dollar sell off.
 
A Biden victory will also provide comfort to risk markets on the landscape of geopolitics, which will also act as a trigger for dollar weakness. Finally, interest rate markets will also likely leave the dollar slightly weaker as nominal rates will remain anchored down at historically low levels, while the fiscal stimulus could lead to higher inflation that will mean real rates are lower.
 
Still, the extent to which we will see the dollar depreciate from a UK perspective may be limited due to what’s going on domestically with Brexit. But with sterling trading more like a more volatile risk-sensitive asset, a Biden victory could create a pronounced short term move higher in the pound against the dollar.
 
It’s unlikely the US government or the Federal Reserve will get in the way of a weaker dollar in the face of such harsh global trading conditions, but the long-term picture may be somewhat more optimistic for the dollar as closer economic management and tax hikes are likely to be on the horizon next year through Democratic leadership. As these measures land, it may begin to slow the financial market lifeline of Fed and US dollar liquidity in recent years, which in turn could dampen risk sentiment and promote demand for the US dollar. So there’s still hope for the dollar, but overall, with a Biden victory, we would expect the dollar weaken over the next four years.
John Wyn-Evans

Markets will be more volatile in the run-up to 3 November. But in the long term, investors should hold their nerve and look to take advantage of any potential mispricings.

John Wyn-Evans, Head of Investment Strategy

 

 

The implications for financial markets

John Wyn-Evans, Head of Investment Strategy, Investec

 

Before we can even discuss the result of the election and its implications for financial assets, there is plenty of potential for surprises in the coming weeks. We already had the extraordinary development of Trump’s coronavirus infection. And remember that the late revelation of an FBI investigation into Hillary Clinton’s private email servers might well have swung the balance against her in 2016. What might the dirty-tricksters pull out of the hat this time, in what is already shaping up to be a polarising contest?
 
The election of a new member of the Supreme Court is also fraught with tension, especially as it might have a bearing on the final outcome of the presidential election. Then we also have the almost daily shifts in expectations for further pandemic-related stimulus packages. It seems almost assured that markets will be more volatile in the run up to 3 November, an expectation visible in the forward curve of volatility index futures. But in the long term, investors should hold their nerve and look to take advantage of potential mispricings that might arise.
 
Then we have the possibility of a contested result, notably in the handful of swing states that will determine the outcome. The historical example of 2000, with multiple recounts in Florida, is not encouraging for share indices, as the S&P 500 retreated more than 10% during the period of uncertainty. However, one must take into account the context of the retreat from the highs of the technology boom at the time, as well as tightening monetary policy. This time the Federal Reserve’s monetary taps are fully open and will remain so.
 
About the only thing that is certain is that the US Constitution demands that a president will be sworn in on 20 January. One might be surprised to learn that, in some headline areas of policy, the differences between the two candidates are not as great as one might be led to believe. However, it is the execution of the details that will be very different. Both are going to use fiscal policy to continue to reflate the economy because austerity no longer wins votes. Both will continue to be “tough on China” because a majority of the American population has a negative opinion on the country.
"All of this spells a period of weakness for the dollar that, when combined with growth-boosting policies that are being echoed globally, will be positive for non-US economies and markets."
However, Biden’s spending policies focus on greener, more sustainable initiatives. The Democrats’ “Green New Deal” is a marquee policy, unashamedly playing to the fears of climate change, but at the same time promising US leadership in the related technologies. $2 trillion or more of expenditure is promised. This is a boon for the green energy sector, and relatively negative for the fossil fuel industry.
 
Biden will also push forward with extending the Affordable Care Act (Obamacare), potentially to the detriment of the healthcare sector owing to price caps and cuts. He promises to be less confrontational on trade, although China will not be let off the hook. We will potentially see the US show a more united front against China with traditional allies in Europe and Japan, for example.
 
Of course, this largesse will have to be funded somehow, and it is probable that taxes will rise, with the focus on reversing at least a portion of Trump’s 2017 corporate tax cuts, as well higher capital gains taxes. Although neither is essentially a positive for riskier financial assets, investors remain relatively relaxed owing to the more predictable nature of future policy. Bond yields could rise in the face of greater issuance of government bonds, but there is a limit to how far the central bank will allow this to go.
 
All of this spells a period of weakness for the dollar that, when combined with growth-boosting policies that are being echoed globally, will be positive for non-US economies and markets, which tend to benefit from a weaker dollar during reflationary periods. The fact that the mega-capitalisation technology companies are also potentially in the line of fire for tighter regulation further suggests that non-US markets could outperform.
 
Trump also wants more stimulus, but in a form that will be less planet-friendly – more oil and more defence spending, for example. It is not entirely clear what his second term trade stance with China would be. Double down the aggression, or seek to endorse his deal-making credentials? Such uncertainty will not be helpful. But he will continue to lean on the central bank to provide liquidity, and therefore it is difficult to see a sharp sell-off developing.

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