US election playbook: navigating the volatility with 40 days to go

  • Temporary dislocation
  • Too many variables
  • Bigger risks ahead

Given the once-in-a-lifetime pandemic, the US election is being held in exceptional circumstances. All else being equal though, we can deduce something about how current polling might play out. The market consensus is that a Biden win and Democrat clean sweep will lead to higher taxes and regulatory risk for a large number of corporates, which will hurt equities.

There are however plenty of other ways in which the market might like a Blue-nami, from pragmatic trade policy to combined loose fiscal and monetary policy.

Trade

Could Biden open up trade with China again? The Democrat candidate is taking a hard line on China – which is playing well with both sets of voters – but will he become more emollient once in office?

Tony Blinken, a senior foreign policy adviser to Biden, said fully ‘decoupling’ with China as urged by Donald Trump is ‘unrealistic’ and ‘counter-productive’. Biden will instead reset ties with China while seeking to redress unfair practices on trade and IP. However, it will be difficult for Biden to withdraw Trump’s tariffs immediately, without gaining significant concessions.

Biden has to play the hand Trump dealt, but he might seek to drive greater consensus with China and work out a more pragmatic trade policy.

MMT

Biden may not have expressed much support for Modern Monetary Theory – in fact he was once a fiscal hawk in the old style – but under a Democrat Congress and White House there would be no rush to reduce the deficit.

In fact, Biden’s economic stimulus plans entail more borrowing. Whilst it is a stretch to suggest that Biden is a supporter of MMT, the economic and social backdrop has changed drastically in recent years and it is gaining traction in more corners of the Democrat machine.

Moreover, the Fed’s recent average inflation targeting shift opens up a new front for MMT proponents in explicitly pushing full employment as the primary goal of monetary policy.

The Fed

At Jackson Hole the Fed announced a policy shift that ought to have a material impact on expectations around rates and inflation. The Fed is taking a more practical approach than in the past when it has been guided by theories about maximum employment, the Philips Curve and inflation.

Instead of saying that the economic outcomes need to fit its models – which have always been nothing more than a best guess – it will let the outcomes drive the policy. Some would say this is a step towards fully embracing MMT, even if Powell has been against this approach in the past.

The fact is that the crisis has thrown MMT from economic theory to economic practice without any real debate. Powell has embraced a central tenet of MMT – why should millions of people be thrown on the economic scrapheap and left unemployed as the price to pay for low inflation.

Under a Democrat-led Congress and White House, MMT proponents will gain a louder voice, with implications for federal economic policy.

Overall, whilst Biden’s tax policy might be tougher on Wall Street, trade and monetary policy could be easier. But it is not quite so straightforward as that. With polls close in the key battleground states and huge uncertainty over the potential impact of postal votes, it is currently difficult to put a price on any outcome, which in turn makes it hard to trade the election per se.

Going long or short based on the outcome is far too simplistic and you could just as easily call it wrong as get it right. What we can say is that the pandemic, the economic recovery and the monetary policy response are longer term going to matter much more. And so, all else being equal is far too simplistic a view to take in what’s a very complex situation.

Will the election outcome be contested?

The only thing the market wants is to get the election out of the way – the only real danger would be a long period of legal disputes post-election, but again this ought only to create volatility at the time and would eventually be forgotten once it all shakes out.

Veiled threats by Trump to not accept a Biden win are probably over-analysed. The Supreme Court (and Secret Service) would see to that. It turns out the most antagonistic election in a generation for the people of America might well end up merely a short term ripple when it comes to markets, given everything else they have to contend with in the long term.

With 40 days to go, the race is tight and in the major battlegrounds it is too close to call. Markets will be volatile and dislocations will occur that present opportunities. The best approach is to be agile enough to contend with both outcomes and no clear winner on the morning of November 4th.

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