US Elections: the aftermath

WHAT YOU NEED TO KNOW

• Political risk, including the US election, was one of the speedbumps we expected in the fourth quarter. Together with the resurgence of the COVID-19 outbreak, it’s one of the reasons why we reduced our US equity exposure from overweight to neutral.
• While the presidential race turned out to be closer than expected, with Donald Trump outperforming expectations, Joe Biden won and was declared president-elect. But we may get a split Congress once again, although this isn’t a done deal yet.
• A ‘divided blue’ scenario is what seems most probable right now, though there’s an outside chance of a ‘unified blue’. If confirmed, this should add to an already large policy stimulus – but not as much as with a Democratic sweep – and no major tax and/or regulatory changes (figure 1).
• Vote recount requests, as well as legal and other challenges, suggest that political volatility will likely remain high for a while longer. While there’s a process for resolution, this could impact sentiment, although financial markets have been quite resilient so far.
• The overall macro backdrop tends to be a bigger driver of post-election market performance than politics. Medical improvements and policy ultra-stimulation suggest that, once the virus is contained, an early-cycle phase of recovery and reflation should take place.

Our framework to think about US political scenarios is based on the observation that the key election outcome, from an economic and market point of view, isn’t just the winner of the presidential race. Rather, it’s whether the US continues to be led by a divided government or if voters deliver a unified government – with the same party controlling the House of Representatives, the Senate and the White House. As history shows, divided US governments tend to face gridlock, while unified governments hold the promise of significant policy change.

Figure 1: Fiscal and monetary easing (% of GDP)

A ‘divided blue’ government is likely to add to an already large policy stimulus.

Source: Quintet, national governments and central banks

While votes are still being counted, the major media outlets have indicated Biden as president-elect. The focus is now shifting to whether and when Trump eventually concedes – a complex situation from a market point of view, which could raise uncertainty further. While the House of Representatives looks set to remain under Democratic control, Republicans and Democrats are in a neck-and-neck race to gain a razor-thin majority in the Senate – with two run-offs in Georgia in January. This may determine whether we’ll ultimately get a ‘divided blue’ or a ‘unified blue’ government.

At the time of writing, it looks as if we’ll continue to have a split Congress, implying a ‘divided blue’ government: the House of Representatives is staying Democratic, while the Republicans look set to retain their Senate majority (but this isn’t certain yet). Even though a ‘unified blue’ is still possible – and there’s been no shortage of surprises in this election – its probability seems lower to us: our best guess is that a split Congress is more likely than not. If confirmed, this would likely result in at least some degree of political gridlock and, therefore, no major policy changes seem probable.

BIDEN’S POLICY PLATFORM

Biden’s plan does look market-friendly, though one near-term risk to the economy is that he may look at European-style, partial lockdowns more favourably than Trump did. In a ‘divided blue’ scenario, we would expect some extra fiscal support to be announced by early next year – a significant but more modest package relative to a ‘unified blue’ scenario. This could be around $1 trillion (about 5% of GDP), with a focus on virus-related income support initially, but also some infrastructure spending further down the road.

While it’s possible that we may see moderate re-regulation efforts affecting sectors such as pharmaceuticals, technology, energy and financials – along with tighter environmental standards – we think that a lack of congressional control should mitigate the extent of any legislative effort on this front. Higher corporate taxes could still come through, but more as a tail scenario and not necessarily as early or as much as initially envisaged. The substance of China relations is likely to stay unchanged, but the communication style could improve. EU relations and the US engagement with the rest of the world, including in multilateral organisations, should get better too.

Things would be different in a ‘unified blue’ scenario, where corporate tax hikes would be the base case – a direct hit to earnings – and sector regulation and oversight would increase more meaningfully. However, simply winning the Senate would not be enough for Biden to implement sweeping regulatory changes. This is because 60 votes out of 100 are needed to overcome filibustering. Conversely, only a ‘reconciliation bill’, which just requires a simple majority, would be needed if he wanted to restore the top marginal income-tax rate to 39.6% for those earning over $400,000 a year and to partially reverse Trump’s corporate tax cuts, raising the rate from 21% to 28%.

Authors

Daniele Antonucci
Chief Economist & Macro Strategist

Bill Street
Group Chief Investment Officer