The US presidential election, which is around the corner, has left many investors on the edge of their seat. Investors are eager to determine the effects on the markets of a Trump versus Biden victory. In this edition of Your Monthly Wau! we look at this in some detail. Public opinion polls continue to show that Joe Biden is the favourite to win the White House. However, the odds of a “Blue Sweep”, which is where the Democrats win control of both the US Senate and House of Representatives, have increased since the end of September according to online prediction markets. See Figure 1.

Interestingly, US Treasury Yields have moved higher over the same period which might be interpreted as the bond – market pre-empting a major increase in stimulus (US government spending), which would be more certain under democratic control. According to a recent analysis done by the Committee for a Responsible Federal Budget, President Trump’s formal policy proposals would increase US. federal debt by $4.95 trillion between 2021 and 2030, while -Biden’s plan would increase the debt by $5.60 trillion. While these are both massive fiscal stimulus plans, there is a stark difference in the policy mix of their proposals. Under Biden, spending is projected to increase by a cumulative $11.1 trillion, partially offset by $5.8 trillion in tax revenue increases and savings through tax hikes on corporations and high-income earners. On the other hand, Trump’s plan includes $5.45 trillion of spending increases and tax cuts over the next decade, offset by $0.75 trillion in savings. See Figure 2.

This difference in the policy mix is significant and shows that Biden would increase spending by over twice that of Trump, with much of that spending expected to be front-loaded in the early part of his term. Overall Biden’s plan would be more stimulating for activity as outright spending is more reflationary than tax cuts as it puts more money in the pockets of consumers (spenders) relative to producers (savers). See Figure 3.

A recent analysis conducted by Moody’s, to estimate how much of each candidate’s promises could be successfully implemented under different combinations of White House – and Congressional control, concluded that the US economy would return to full employment in the second half of 2022 under President Biden, compared to the first half of 2024 under a re-elected President Trump. If this were to occur the output gap brought about by the pandemic would close and would likely see inflation rise which would prompt the Federal Reserve to reassess their current highly dovish stance. See Figure 4.

BCA’s Geopolitical Strategy team sees a Blue Sweep as the most likely outcome, although they forecast the race for control of the Senate as being much closer. Below is a look at a four different (not complete) potential outcomes with probabilities attached together with a short analysis of each.

1. Biden wins in a Democratic sweep: BCA probability = 27%. The US economy will benefit from higher odds of unconstrained fiscal stimulus in 2021. Financial markets will simultaneously have to adjust for the negative shock to US corporate earnings from higher taxes and regulation. Government bond yields should rise on the generally reflationary agenda.

2. Trump wins with a Republican Senate: BCA probability = 40%. This scenario, which is the current situation, sees a reelected President Trump still facing opposition from House Democrats on most domestic economic issues, forcing him to tilt towards more protectionist – foreign and trade policies in his second term. Fiscal stimulus would be easy to agree, though not as large as under a Democratic sweep. The risk to a cyclical recovery remains, due to the global trade war as Trump’s tariffs are likely to not be limited to China only, but may affect the European Union too.

3. Biden wins with the Senate staying Republican: BCA probability = 28%. This outcome would be the most positive for financial markets as there would be a reduced chance of a full-blown trade war with China, however with the added benefit of no new tax hikes.

4. Trump wins with a Democratic Senate: BCA probability = 5%. This is the least likely scenario but one that could produce a big positive fiscal impulse. There would be no tax hikes but there would be spending on areas where he agrees on. Such a scenario would still see that risk of elevated trade tension with China. The long-term outlook for the Dollar is bearish. The idea being that increased government spending will see the US twin deficits widen as aggregate demand increases. In anticipation of higher inflation, foreign bond investors are likely to continue fleeing the US market which would drive down the Dollar in the process. Increased spending in the US is also likely to filter into other global markets which should lend support to global growth and so too boost more cyclical currencies in the process. In the short term, many risks to the view on a softer Dollar are present, with the election result being the most significant. A Biden victory could see the Dollar weaken initially. On the other hand, November has historically been a good month for the Dollar. The chance of reinstated lockdowns because of the pandemic is present and affects the outlook for a global recovery. A tilt away from risk because of renewed COVID-19 fears would be Dollar bullish.