With less than a week to go before the US presidential Election, where does the race stand? The polls, betting odds, and the balance of expert opinion point to a Biden victory and “Blue Wave” scenario in which the Democrats control both the House of Representatives and the Senate. The trailing average of recent national polls compiled by Realclearpolitics.com, for example, shows Vice President Biden with a comfortable lead that exceeds Hillary Clinton’s at this time four years ago.
A Clash of Distinct Economic Philosophies
If Trump can hold on to the White House, he would pursue an “all out push for growth” in a second term, underpinned by additional tax cuts, deregulation, and an attempt to “wedge open” foreign markets for US companies via the threat of tariffs, according to Nathan Sheets, chief economist and head of global economic research. Trump would need to be more of a “dealmaker” in any second term because, while the Senate is in play, he will likely be dealing with a Democratic House of Representatives. We may see an expansion of the trade war with Europe if Trump secures victory. Under a Biden Administration, in contrast, the government would play an important role in addressing the distorting effects of inequality on the economy. Biden would seek to improve economic performance by making strategic investments in people, education, health care, infrastructure and the environment, Sheets said. If Biden wins in a “Blue Wave” that hands the Senate to the Democrats, he would have significant latitude over tax policy, spending, and regulation. We should expect a large stimulus package in the first quarter of 2021, higher taxes and more aggressive regulation (in areas related to climate, consumer protection, energy, and worker rights, etc.). Higher taxes, however, may not come in 2021 given the economy’s fragile state.
Sheets believes we are likely to see fiscal stimulus regardless of who is elected president; the difference would be in the composition of the stimulus package. Under Trump, the stimulus would be achieved largely through tax cuts; under Biden it would be done through spending. He believes the best scenario for growth in the next few years is one in which Democrats control the presidency and Congress because stimulus would probably be larger and arrive in a timelier manner. The next six months are critical to get us through the pandemic, according to Sheets. After that the economy should naturally recover. However, there is an economic downside risk regarding the size and timing of any Biden tax increases. The political climate will likely require any President to stay tough on China, however, under Biden, this would likely occur through diplomacy and joint action with allies. US Federal Reserve policy would likely remain stimulative and is unlikely to be impacted by the election result.
Trump Fuels Increased European
Solidarity, but Europeans Still Want a President Biden
The US has historically advocated for European Union (EU) stability and integration, according to Katharine Neisse, chief European economist, but since 2016, we have seen a marked change in US-European relations, with President Trump supporting Brexit and even calling the EU a “foe.” Opinion polls show Europeans overwhelmingly rooting for a Biden win, however, Trump’s hostility has unwittingly strengthened the European project by fueling greater European solidarity. This is reflected in productive Brexit negotiations, the unprecedented European fiscal recovery package for COVID relief, a unified vision on addressing climate change, and increased support for the euro among member countries. A Trump victory would likely lead to increased US-European trade tensions, including tit-for-tat tariffs on autos, that could wind up causing greater economic damage than the current US-China trade conflict, Neisse said. In contrast, a Biden victory would likely lead to repair and renewal around trade issues and “competitive cooperation.” There would likely be progress on key trade issues, including World Trade Organization reform, a unified approach to dealing with China, and efforts to modernize the global trading framework to bolster trading in services. Europe and the US would also likely forge a productive partnership to address climate change.
Rate to Stay Low and the US Dollar to Weaken
Bond yields jumped substantially on two occasions during President Trump’s first term: in 2016 after his election and again in 2018 when large federal tax cuts took effect. Are we in store for another spike in rates given the expectation of more stimulus after the election? Robert Tipp, chief investment strategist and head of global bonds, believes not because of differences in the macroeconomic context between now and 2018. First, back in 2018, the Fed was running a “rogue high-rate monetary policy” compared to the rest of the world. Today, policy rates are pinned firmly at zero and are likely to stay there for a while, bringing them more in line with rates set by other major central banks. Next, the 2018 fiscal stimulus (in the form of tax cuts) was procyclical, meaning it was implemented when the economy was running hot and with very little excess capacity. Investors correctly anticipated this combination would lead to higher policy rates, and indeed, the Fed continued to hike interest rates throughout 2018.
Today, the economy is depressed due to the pandemic with lots of excess capacity, and the expected fiscal stimulus would simply push the economy toward more normal conditions, Tipp said, adding that the secular drivers keeping rates low are still firmly in place. Finally, investors are expecting post-election stimulus this time, while Trump’s election in 2016 and the passage of the tax bill (in the final days of 2017) surprised them. Bottom line: the recent move in the US 10-year Treasury yield from ~50 basis points (bps) to ~80 bps reflects expectations of coming stimulus, according to Tipp, who believes the 10-year rate is likely to be in the bottom half of a 50-to-100-bps range during the next six to 18 months.
With respect to the US dollar, Tipp believes it is likely to weaken due to the collapse of interest rate differentials that previously favored the dollar and the Fed’s desire to lift inflation. Ballooning US budget deficits and the continued deterioration in the US trade balance provide additional headwinds for the dollar. Finally, increased policy uncertainty should weigh on the dollar, especially since US policymakers are no longer providing investors with a “long-term anchor” on where US structural budget balances should be. A weaker dollar should be good for risky assets, including fixed income spread product, emerging market debt and non-dollar investments.
A Biden Win Impacts the Sector View More Than the Overall Credit Market View
We are in a “golden age” for credit, according to Greg Peters, head of multi-sector and strategy, who believes this is likely to remain the case regardless of who wins the US presidential election. In Peters’s view, we are in a rare era where corporations are managing for bondholders rather than shareholders. A “back to the wall mentality” among C-Suite executives has them focusing on generating and preserving free cashflow and deleveraging corporate balance sheets. Thus, we are seeing fewer share buybacks, more dividend cuts, and less capital expenditure. Even the massive bond issuance we have seen recently has been beneficial to bond holders, as it is the result of companies terming out their debt. All of this is favorable for credit investors. A Biden win is more likely to have sectoral implications rather than a broad market effect, in Peters’s view. Investors need to weigh the negative impact of a higher tax bill for companies against the positive impact of faster operating earnings growth associated with broad fiscal expansion. He believes the emphasis should be on the latter since bondholders are focused on EBITDA rather than EPS (firms pay bondholders with pretax earnings). Thus, the impact of a Biden win should be credit-market positive on balance. Gridlock is not a good thing this time around, as we would likely see a smaller fiscal package if we have divided government, according to Peters.
Municipal bonds should do well under a Biden/Blue Wave scenario due to greater fiscal support for state and local governments and an anticipated reinstatement of the unlimited deduction of state and local taxes. Higher tax rates for the wealthy should also bolster demand for municipals given their tax-advantaged status. Consumer-related sectors would benefit from fiscal stimulus. Renewable energy, ESG-related issues, and mortgage insurers would likely benefit under Democratic policies. Emerging market debt should benefit from a less-hostile external policy environment, fiscal expansion and the weaker dollar view expressed above.
The losers under a Biden administration would include segments of consumer loan market/asset backed securities that get caught in the crosshairs of reinvigorated consumer-protection regulations. Coal-heavy power producers and energy more generally would suffer under anti-fossil fuel policies. However, within energy, the devil would be in the details, and there would be significant opportunity to “add alpha” with issuer selection, Peters said. Tech would suffer on the regulatory side and increased pressure from a global tax perspective. However, one beneficial offset would come from an anticipated relaxation of H1B visas and greater access to skilled foreign workers.
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