Tension is running especially high ahead of elections in the U.S. that are being variously billed as a kind of make or break moment for America’s democracy.
Over the past month, Republicans sought to galvanize public opinion around immigration, a risky strategy considering the xenophobic overtones and the extent to which doubling down on fear risks distracting from the economy, a bright spot for a President whose first two years in office were defined by turmoil and divisive politics.
Trump has zeroed in on a migrant caravan en route to the U.S. from Central America, going so far as to deploy thousands of troops to the border at a rumored cost of up to $10 million per day. It’s a gambit designed solely to cast himself as the protector of American values which, according to Trump, are facing an existential threat from “invaders” whose skin color happens not to be white.
The tax cuts, the Trump administration’s crowning legislative achievement, did the trick when it comes to juicing corporate earnings and buoying the stock market, but an internal GOP poll leaked in September showed voters are now wise to the fact that corporations and the wealthy benefited disproportionately, contrary to the “middle class miracle” billing.
Specifically, the poll showed voters overwhelmingly believe “large corporations and rich Americans” benefited more from the original tax cuts than middle class families. When I say “overwhelmingly”, I mean it wasn’t even close – the margin was 2-to-1:
(Internal RNC poll)
A last minute effort to convince voters of the GOP’s sincerity with regard to improving the plight of working Americans fell flat when the media pounced on the impossibility inherent in Trump’s contention that a “major tax cut for middle income people” was set to be unveiled before the elections. No such announcement was possible as Congress was out of town and within 48 hours of Trump’s ill-fated October 20 claim, it was readily apparent that no plan was in the works.
In addition to being viewed as a boon to the wealthy and corporations, the tax cuts came at a heavy cost. During his first full year in office, Trump presided over the largest U.S. budget deficit since 2012 and now holds the record for most interest paid in a single year. Last week, Treasury’s Q4 refunding plan showed Steve Mnuchin is all set to steal the record from Tim Geithner, issuing $83 billion in securities this week, an astonishing total considering the U.S. economy is hitting on all cylinders. Trillion dollar deficits are right around the corner.
There’s no shortage of research out there with regard to the likely market and policy implications of the various possible election outcomes. We’ve documented many of the projections here over the past couple of weeks, but needless to say, they’re still coming in hot and heavy as Wall Street braces for a possible surprise.
History suggests it’s unlikely that any outsized reaction in markets will be sustained. “It is important not to overreact to an election result [as] there is no clear relationship between past midterm election outcomes and subsequent equity market performance” Credit Suisse wrote over the weekend, before reminding you that “despite some risks, the likely result of this election is legislative stalemate, a situation that has coincided with good market conditions in the past.”
Still, if the last three years have taught us anything, it’s that pre-election polls can be wrong and as such, it’s worth highlighting some brief commentary and a couple of handy visuals that give you an idea of what to expect should the base case (Democrats retake the House and Republicans retain the Senate) not materialize.
First, here’s Goldman’s summary of the two “risk scenarios” and the likely market implications should they be realized:
In our view, the two risk scenarios most relevant for markets are: 1) Democrats take the majority in the Senate and the House and 2) Republicans keep control of the House and the Senate. In the first case, where Democrats take control of both chambers, we would expect to see lower Treasury yields due to reduced prospects for fiscal stimulus and therefore lower growth expectations. We would also expect to see weakness in equity sectors exposed to regulatory and tax policies, and underperformance in pharmaceutical stocks given the higher likelihood of new drug price regulations (even though most regulatory issues require 60 votes to pass). In the second case, where Republicans maintain control of both chambers—which has become increasingly likely in recent weeks but remains far from the base case—we would likely see higher Treasury yields and higher equities (particularly pharma stocks) on stronger growth expectations, reduced regulatory uncertainty, and more fiscal stimulus (e.g. a small tax cut that could pass via the reconciliation process). If taxes do come into play, the administration could delay further tariffs to keep the votes of Republican Senators in the Midwest, meaning the impact on the Dollar might be more ambiguous.
If you, like the President, are a visual learner and are thus predisposed to favoring infographics that communicate potentially complex dynamics in a fashion that’s easy to digest, SocGen has you covered.
First, here’s a chart documenting what the bank expects in terms of market impact from the base case as well as the two risk scenarios across assets:
And here’s a similar chart that documents policy outcomes under different assumptions:
Perhaps most notably, SocGen does not appear to share the consensus view that gridlock would be a positive development for markets.
Generally speaking, analysts seem to think that with most of the market-friendly aspects of Trump’s agenda already on the books, divided government might be the best case scenario as it would stymie any market unfriendly escalations on key issues (not the least of which is obviously trade) but also make it virtually impossible for any of the existing policies to be materially rolled back. Again, SocGen doesn’t appear to agree.
“If Republicans lose either the House or Senate, SG strategists would expect more volatility on risk assets and a rising risk premium”, the bank says, in a note dated Monday, on the way to cautioning that “the political and economic agenda has driven the financial markets for the past two years – so political gridlock and uncertainty will not come without pain.”
Fair warning, I suppose.