With the US elections resulting in a win for Democratic candidate Joe Biden, markets are positioning themselves for the implications of US economic and foreign policy on the world stage.
Importantly though, it appears as though a “blue sweep” has not materialised, with the Republicans having likely retained their majority in the Senate and the Democrats’ majority narrowed in the House (Incumbent Donald Trump is contesting the election results, meaning a final result may take some time. Furthermore, the outcome of the Senate race will only be known for sure after the run-off elections in Georgia on 6 January).
The US has an inbuilt system of checks and balances within the US legislature, which means that a party needs to control every area in order to govern easily without gridlock. With the blue sweep scenario falling away, Biden may have difficulty implementing policy initiatives, such as higher corporate and capital gains taxes.
The large tech firms, such as Alphabet (Google), Facebook, Amazon and Apple may also find themselves subject to less regulatory scrutiny. This has certainly explained the strong run by US equities in the days following the election.
Importantly, a Republican Senate will limit the capacity to implement a large stimulus package. “Biden’s plan consists of raising spending by between $2 trillion and $4 trillion, partly funded from higher taxes on high net worth individuals and corporates,” says Tertia Jacobs, Treasury Economist at Investec. “The Republicans support fiscal stimulus, but at a much lower level. They are also opposed to higher taxes.”
This means that the Federal Reserve is likely to continue to do the “heavy lifting” in terms of keeping rates low and maintaining the levels of asset purchases.
The other big move has been in emerging market currencies, bonds, and equities.
“Both policies (Democrat and Republican) could lead to a weaker US dollar, as the twin deficits (budget and current) rise, though the fiscal multiplier under the proposals of Biden would be expected to be larger,” says Jacobs.
“This likely supports global capital flows returning to emerging markets, especially as global growth is on a firmer footing. The expectation of the direction of emerging market currencies is an important driver of global capital inflows, as currency appreciation/depreciation is an important component of the total return generated on an investment,” she adds.
Dave Murray, Head of Equity Market Research, Investec Corporate and Instututional Banking, argues that a tailwind of a stronger emerging market currency environment and lower-for-longer real yields is likely to support a rotation back into the so-called higher Beta assets, including emerging market equities.
“We see a Biden presidency as being supportive for precious metals and the broader commodity complex, and is likely to encourage a more powerful and sustainable rotation from investors away out of safe haven asset classes/markets into the deeper value and higher Beta asset classes, including emerging markets and SA,” he says.
However a gridlock outcome implies no tax increases and a smaller spending package passed by the House of Representatives, which would be a more neutral outcome for the financial markets, Jacobs points out.
Less disruptive foreign policy
US foreign policy plays a crucial role in driving financial market volatility. Trump’s America First policy saw a shift away from multilateral, rules-based policies, towards bilateral negotiated policies and were heavily influenced by Trump’s personal relations with specific country leaders, Jacobs points out.
“Policy uncertainty stemming from Trump’s change in US trade policies, alongside a deterioration in US-China relations as technology competition intensified, created a less predictable operating environment for emerging economies,” she says.
“Trump’s foreign and trade policies approach of using sanctions and trade tariffs in an opportunistic and often unpredictable manner, has complicated international trade relations.”
This lack of predictability has negatively impacted global growth expectations and the direction of US monetary policy, notes Jacobs, which in turn reduced the appetite for emerging market assets and boosted demand for US dollars and other safe haven assets.
Biden is likely to pursue a less disruptive and more predictable policy path, working through more formal diplomatic channels and engaging the US’s traditional allies in matters of trade and political relationships, says Jacobs.
“This does not guarantee a less tough stance on China, or a reversal of policies implemented under the Trump administration, but it does suggest a more considered and predictable policy process. Biden has promised a return to more multilateral diplomacy, including on climate change policies,” she adds. “However, relations with Russia and Turkey, and the Middle East situation in general, are likely to remain unpredictable.”
As part of a shift to multilateralism, Biden will likely re-commit to international institutions like the World Health Organisation and rejoin the Paris Accord on climate change. The implication is that the world’s leading economies will work more closely in driving the growth of the green economy in a post-Covid world.
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