In a tightly contested U.S. election, where the issue of postal votes could decide the victor, what does this mean for financial markets? Paul O’Connor, Head of the UK-based Multi-Asset Team, looks ahead to prospective policy paths and the dwindling prospects of a Biden fiscal bonanza.
- Investors are focusing on two themes as they evaluate the outcome of the election – the fiscal thrust and the potential policy proposals from the new president – against a backdrop of an incomplete global recovery.
- The dwindling possibility of a Democrat-led Senate has dealt a serious blow to prospects for a reflationary U.S. fiscal stimulus, while also limiting the likelihood of higher corporate taxes and more regulatory intervention.
- Investors are putting precautionary cash balances back to work and unwinding pre-election hedges.
The U.S. presidential race remains undecided, but markets have already drawn their conclusions about how things will play out. As the electoral results rolled in, the price action has confirmed that investors are focusing on two sets of themes as they evaluate the evolving election outcome: the overall fiscal thrust from the new administration and potential president-specific policy proposals beyond this.
The economic backdrop to this election is one of an incomplete global recovery that remains threatened by the continued spread of COVID-19 in many major economies as well as fast-fading fiscal support measures. With interest rates and bond yields already crushed, investors see limited scope for central banks to revive growth if the global recovery loses momentum. The consensus emerging in financial markets is that fiscal policy now needs to take more responsibility for supporting global growth than it has done in the past decade. That is why the fiscal policy proposals of the two main presidential candidates have been given such unusual prominence in this election.
Of course, presidential policy preferences will not be the only factor determining the fiscal program of the new administration. The party leadership of the Senate will have a huge bearing on the size and nature of the package that will ultimately be delivered. The dwindling possibility of a Democrat-led Senate has dealt a serious blow to prospects of the “blue wave” scenario that many had come to anticipate in the run-up to this election. While the Senate result is by no means finalized and might not even be resolved until January, a Biden fiscal bonanza is now a longshot, having been a hot favorite theme on the eve of the election.
At face value, the rebound in risk assets might seem incongruous against the backdrop of fading prospects for a reflationary U.S. fiscal stimulus. Still, the sectors that would have been the key beneficiaries of Biden’s spending plans have taken a post-election hit and U.S. bond yields have moved lower, reflecting the anticipated demise of the big stimulus program. However, for the major U.S. equity indices, these effects have been dwarfed by the rebound in health care and technology stocks and other sectors that have been celebrating the view that Joe Biden’s plans for higher corporate taxes and regulatory intervention seem likely to be smothered by a Republican-led Senate.
In a broad sense, the market reaction to the unfolding election news suggests that financial markets would prefer to see a constrained Biden presidency, rather than one where he is given a mandate to deliver the strongest version of his preferred policies. This is not an unusual response; in fact, history tells us that split governments have typically delivered better equity market performance than unified ones and Democrat-led ones have been best of all. In this case, we would expect the Senate’s dilution of a Biden administration program to involve a shift in priorities towards providing COVID-19 fiscal relief and raising infrastructure spending, with a move away from the sorts of redistributive policies and regulatory intrusions that threatened to shake some of the stock market behemoths.
Equity markets usually bounce after big anticipated risk events, like U.S. elections. With various indicators suggesting that most investors had assumed a more defensive position in the run-up, a typical relief rally seems also to be underway here. Investors are putting precautionary cash balances back to work and unwinding pre-election hedges. The prospect of a Biden-led administration pivoting the U.S. government back towards more orthodox and multilateral approaches to international relations, and improving trade relations with Europe and Japan, offers some specific support to this general theme.
No Game Changer
So, assuming the result pans out as seems increasingly likely, with a Biden-led White House and a Republican Senate, we will have an election result that is by no means as much of a game changer as a Democrat clean sweep would have been. This is a combination that will undoubtedly often arrive at legislative gridlock and one that extinguishes hopes of a fast shift to a transformational U.S. fiscal reflation. Accordingly, the market response so far has involved the pricing-out of expectations of a “blue wave” scenario in some assets and relief rally celebrations in others.
While it remains quite possible that this election will take longer to be formally resolved than most others, financial markets will approach this probabilistically, as ever, not waiting for every detail to be formally verified. The election result will soon be priced in, even if the outcome is not officially agreed. Attention will then shift back to the economy and to the continued impact of the coronavirus on macro dynamics. Economists are cutting forecasts for fourth-quarter growth in Europe, reflecting the latest upsurge in COVID-19. With the virus now gathering momentum in the U.S., the associated near-term economic risks might attract more investor attention once the election news subsides.
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