As the U.S. presidential race continues to be neck and neck
according to opinion polls, our Chief Fixed Income Strategist
considers the possible market implications if some policies
proposed during this campaign are implemented.
----- Transcript -----
Welcome to Thoughts on the Market. I am Vishy Tirupattur, Morgan
Stanley’s Chief Fixed Income Strategist. Along with my colleagues
bringing you a variety of perspectives, today I'll be talking
about understanding market dynamics against the backdrop of U.S.
elections.
It's Monday, Oct 28th at 1 pm in New York.
The outcome of the U.S. elections, now just over a week away, has
been at the center of every discussion I have had in the last
several days. There have been significant moves, not so much in
the opinion polls – but in prediction markets. In the opinion
polls, the presidential race remains tight and neck-to-neck in
key swing states with poll numbers well within the margin of
error. But some prediction markets have shifted meaningfully
toward Republicans in the contests for both the presidency and
control of Congress.
Financial markets have also moved a lot. Stocks exposed to a
Republican win outcome have risen a fair bit.
To understand the potential policy changes that can have an
impact on markets, I think it is crucial to understand the
sequencing of those policy changes.
Given the moves in the prediction markets, let us first frame a
Trump win scenario. It seems reasonable to bucket the possible
shifts into three categories – fiscal policy, immigration
controls, and tariffs.
Meaningful changes in fiscal policy require control of both
houses of Congress; and even in a Republican sweep, scenario
legislation would still be time-consuming and likely come last.
We don’t really have many details on how changes to immigration
policy would be implemented and so their timing remains very
unclear. On the other hand, given broad presidential discretion
on trade policy, Trump’s expressed intentions in his campaign
messaging, and the precedent of his first term, tariff changes
would likely come first.
Our economists have looked at the potential impact of tariffs on
the economy. They concluded that broad tariffs imply downside
risks to growth through declines in consumption, investment
spending, payrolls, and labor income, and upside risks to
inflation. Their estimates suggest that imposing all the tariffs
currently under discussion could result in a delayed drag of -1.4
per cent on real GDP growth and a more rapid boost of 0.9 per
cent to inflation.
How do we reconcile the equity market’s reaction to the
increasing odds of a Trump win in some prediction markets with
the idea that there will be a drag on GDP growth and boost to
inflation that our economists assess?
Two explanations. Markets could be counting on the prospect that
all tariffs would not be imposed. Or at least would be sequenced
over an extended period, with some coming much later than others.
Also, markets could be putting greater emphasis on the revival of
“animal spirits” driven by expectations of regulatory easing,
which is hard to define or quantify.
Let us look at other markets.
In the bond markets, treasury yields have risen notably in the
last month. Many investors see the Republican sweep outcome as
most bearish for US Treasuries, based on the experience of the
2016 election. As Matt Hornbach, our global head of macro
strategy has noted, there are meaningful differences between the
Fed’s monetary policy today and the pre-election period in 2016,
suggesting that any rise in Treasury yields would be more
contained this time, even in a Republican sweep outcome.
In 2016, markets were pricing in about 30 basis points of rate
hikes over the next 12 months. Contrast that to the current
market expectation of about 135 basis points in rate cuts over
the next 12 months. Also, in the year after the 2016 election,
expectations for the Fed Funds Rate rose nearly 125 basis points.
A similar rise in expectations for Fed policy now would require
market participants to expect the Fed to stop cutting
immediately; and refrain from further cuts through 2025. This
seems like a remote possibility – even under a Republican sweep
elections scenario.
Given the recent moves across markets and the expectations they
are pricing in, markets may now be somewhat offside should Harris
win, as they would have to reverse the course.
Elections are a known unknown. Based on opinion polls, this race
remains extremely tight, and multiple combinations of
presidential and congressional outcomes are very much in play. We
must also contend with the prospect that determining the outcome
may take much longer this time.
Thanks for listening. If you enjoy the podcast, please leave us a
review wherever you listen and share Thoughts on the Market with
a friend or colleague today.
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