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US election special: market reactions on different scenarios

19 Oct 2020 07:12 PM

US election special:  market reactions on different scenarios

 

With less than a month to go until the US presidential election, investors are increasingly focused on how the outcome will impact financial markets. There is no automatic rule for how the dollar and equity markets will react to a Trump or Biden win – it depends on whether the victor will also have full control of Congress or not.

In this article, we will examine five scenarios on the market impacts if there is a democratic sweep, a republican sweep, a divided government, or an inconclusive outcome.

Highlights

The November 3rd US election between Donald Trump and Joe Biden is likely to have dramatic impacts across different markets, from equities to commodities to currencies, and traders face the challenge of figuring out what they might be. The outcome will determine whether the next round of fiscal stimulus will be powerful or mild, whether the trade war with China will escalate further, and whether corporate and capital gains taxes will be raised or cut.

The latest opinion polls by RealClearPolitics have Biden ahead by 10%. But remember, national polls have little relationship with the election result thanks to the US electoral college system. In 2016 Hillary Clinton won the popular vote by three million votes, but still lost the election. What matters are the polls in battleground states, which are much closer.

For the markets, the crucial point is whether the US gets a unified government, where the president’s party also controls both chambers of Congress.

If not, much of the president’s agenda would probably be opposed by the opposing party as each chamber has veto powers over legislation. At present, the Democrats control the House of Representatives while the Republicans control the Senate.

Democratic sweep

This scenario is the most likely outcome if the latest polls are to be trusted. If the Democrats keep the House and take the Senate and presidency, this scenario could be negative for the dollar but boost the stock market.

This is because the Democrats are set to introduce a massive fiscal stimulus package, which would blow up the government deficit, in the process driving the dollar down. They intend to finance this by raising taxes on the wealthy, corporations, and capital gains, but this would face serious resistance because American politicians rely on donations from wealthy individuals and corporations. Plus, raising taxes in the middle of a recession could hit growth just when the economy needs it most.

Also, the dollar could take a hit from the more stable foreign policy a Biden administration may bring. Even though Biden might not be friendly to China, his approach is likely to be softer than President Trump’s and he is unlikely to introduce similar high tariffs on Chinese imports. This could boost global trade flows and increase dollar liquidity abroad, which could increase investment and boost US imports over exports.

Other currencies could rise against a weaker dollar. For example, the Australian dollar could rise against the USD because of Australia’s close trading relationship with China.

Turning to stocks, many argue that a Democrat win would be a negative outcome because of tax concerns. However, if investors sense that the fragile economy is likely to keep Biden from significantly raising taxes, but not dissuade him from huge spending increases, a Democrat victory could drive the markets higher.

A Biden win means a boost for renewable energy companies, as his administration would likely push hard towards green energy. Conversely, energy and oil companies would suffer most – along with crude prices.

Republican sweep

This is a very low-probability scenario, as it would require Republicans to take the House, which given current polling appears extremely difficult. If they somehow manage this, the result may be a stronger dollar and a higher stock market.

Lower deficits and fears that Trump might restart the trade war with China - or even turn his tariffs on Europe - would push the dollar higher and send investors toward safe-haven assets.

The Republicans would be unlikely to deliver as much fiscal spending as the Democrats would, but would be more likely to further cut taxes and regulations, cheering stock markets in the process. The energy and financial services industries would likely get the biggest boosts.

Divided Congress under Biden presidency

This would imply less fiscal stimulus, and almost no chances of tax hikes as Senate Republicans would return to the obstructionism they displayed under President Obama. The deficit would likely increase and trade policy could become less volatile under Biden overall - meaning a weaker dollar.

For equities, this scenario may be slightly negative. The risk of higher taxes would be virtually eliminated, but the chances of a big-spending package would also decline amid the political deadlock.

Trump wins but a divided Congress

This would continue the status quo, where the Democrats would block much of Trump’s domestic agenda, leading him to focus mostly on foreign policy, where the president has more independence. The trade war with China could escalate, supporting the dollar and hurting commodity-related currencies such as the Australian dollar.

This outcome could be a slight positive for equities. Trade tensions might flare up, but there could also be some fiscal stimulus and deregulation.

What happens if the result is a disputed outcome?

This is the worst of all worlds for equities in the short term, but the best for speculators. Trump has refused to commit to a peaceful transfer of power if he loses and might challenge the result in the courts.

The last time this happened was back in 2000, with the dispute result between George W. Bush and Al Gore. The stock market fell 12% over the five weeks between the election and the Supreme Court stopping a recount in Florida, with the US dollar displaying great volatility.

Conclusion

Ultimately, the market reaction on and around November 3rd will depend the most on who controls Congress and whether we have a clear result on election night.

While Biden currently looks set to win, there still several weeks to go and the world should not count Donald Trump out just yet - especially in this volatile environment.

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