Macro & Market Implications of US Elections

Summary

• A Republican sweep (red WH and Congress) could result in stagflation and force the Fed to hike.
• Meanwhile, a Democratic sweep (blue WH and Congress) would likely align with the Fed’s current projections.

Market Implications

• A Trump victory would likely lead to bear steepening in the yield curve, and a stronger USD especially vs MXN and big exporters.
• A Democratic victory would likely lead to muted market reactions, a weaker USD, and fiscal status quo.
• A clear, uncontested result would boost stocks either way. Under Trump, sectors like border control, deregulation, and oil should outperform, while clean energy could suffer. Under Harris the market would be concerned about higher corporate taxes.
• Commodities are less likely to be affected by elections. But we see gold and PGMs stronger under most scenarios.

Elections Outcomes Could Drive Sweeping Policy Changes

Here, we update our May discussion of the macro and market consequences of the November elections. Table 1 lists election outcomes, associated betting odds, policy changes and market impacts.

Betting markets see somewhat higher risks of a blue rather than red White House (WH), in line with polling showing Harris ahead but within the margin of error. However, the presidential election outcome alone is not enough to draw market implications as key policies need the support of Congress.

Should the WH remain blue, betting markets see a blue House and red Senate (purple Congress) as most likely, followed by a Blue House and Senate, with a low but nonzero risk of red House and Senate. This is because the blue wave that would carry Harris to the WH would also manifest in Congressional elections. At the same time, the 2024 election setup makes a blue House much more likely than a blue Senate (see Elections Monitor for details).

Should the White House turn red, betting markets see a red Congress as the most likely associated outcome, with a lower risk of purple Congress, for reasons described above.

Table 1 shows three key policies:

Fiscal Policy

The budget deficit would be largest under a red WH and smallest under a blue WH with a red Congress.

The current debt ceiling suspension ends on 1 January 2025, so the incoming administration must make fiscal policy choices early.

With a red WH and Congress, the fiscal deficit would likely increase as a Trump administration would implement large tax cuts that historically have led to increased deficits.

A purple Congress would likely change the picture little, as a blue House would be more likely to protect social expenditures than to decrease the budget deficit.

A blue WH and Congress, by contrast, would maintain the status quo. That is, keep the deficit around current levels of 7% of GDP as Harris has announced higher social spending funded through higher taxes.

A blue WH facing a purple or red Congress could face difficult debt ceiling negotiations. The last two precedents in 2011-13 and 2023 when a blue WH and Senate faced a red House yielded very different outcomes. The debt ceiling crises of 2011-13 saw a reduction in the deficit to 2.7% of GDP in FY2014 from 8.3% in FY2011, even though unemployment was well above its long-term value.

By contrast, the debt ceiling agreement of mid-2023 yielded no discernible reduction in the budget deficit (the improvement in the deficit since then reflects the Supreme Court’s cancellation of the administration’s student loan forgiveness).

These outcomes could reflect the negotiators’ skills as well as a stronger Republican bargaining position in 2011-13 than in 2023. The Republican majorities were larger in 2011-13 (49 and 33 seats) than in 2023 (9 seats). In addition, in 2023, Republicans were divided and ended up dismissing the Speaker of the House (and chief debt ceiling negotiator), a first in the history of Congress.

We therefore assume stronger fiscal consolidation under a red than a purple Congress.

Tariffs

Currently, average tariffs on goods imports are about 2%. Trump has promised to raise import tariffs to 20% across the board, with tariffs on imports from China increased to 60%. This can be done by executive order through section 301 of the 1974 Trade Act and section 232 of the 1962 Trade Expansion Act. So Congressional approval is not required.

Harris has not announced tariff increases.

Immigration

Trump has promised to expel all illegal migrants currently in the US, estimated by the Department of Homeland Security to number 11mn in 2022. If implemented, this would represent a supply shock commensurate with the pandemic when the labor force shrunk by 8mn. The deportations would also have a large negative impact on demand.

Expelling 11mn people would require large additional funding and possibly legislative changes to compel cooperation from state and local governments. Expulsions of illegal migrants peaked at 400,000 per year during the Obama administration but fell to 300,000 per year during the Trump administration and 100,000 in 2022.

Getting the financial and legislative support required for such a large-scale operation would likely require a red Congress. Without such support, we assume a Trump administration would struggle to expel more than 1mn illegal migrants.

By contrast, Harris is not planning stepped-up expulsions and has promised to seek bi-partisan consensus on border security and immigration policies.

Election Outcomes Would Drive Very Different Fed Scenarios

These policy combinations would yield different growth and inflation outcomes, with associated Fed policy responses. We assume the Fed cuts the FFR twice more to 4.4% in 2024. The macro scenarios below describe 2025.

Red WH and Congress: Stagflation

• Deep recession caused mainly by large contraction in labour force.
• Inflation accelerates back to pandemic highs due to reduced labour supply and higher tariffs. Mass deportations increase the bargaining power of native-born workers who demand higher wages to make up for the loss of purchasing power caused by the tariff increases. While mass deportation lowers household consumption, an increase in the budget deficit offsets this negative demand shock.
• The Fed has no choice but to provoke a recession to bring aggregate demand in line with the permanent reduction in aggregate supply caused by the mass deportation. It hikes 200bp to 6.4%.

Red WH and Purple Congress: Below-Trend Growth, Accelerating Inflation

• Aggregate supply growth slows due to the imposition of widespread tariffs.
• Aggregate demand growth accelerates due to the increase in the budget deficit.
• Growth slows below trend.
• Inflation accelerates back to about 3.5%.
• The Fed hikes 50bp to 4.9% to stabilize inflation expectations, while the US economy adjusts to the new relative prices.

Blue WH, Blue or Purple Congress: Fed SEP

• This is broadly the macro scenario described in the Fed SEP: Q4 growth at 2% and core PCE at 2.1%.
• Budget, tariffs and immigration policies are roughly unchanged.
• With a purple Congress, fiscal consolidation is limited. Growth and inflation are somewhat lower than in a blue Congress scenario.
• Growth and inflation are a tad lower with a purple Congress to reflect the limited fiscal consolidation.
• Per the SEP, the Fed cuts 100bp to 3.4%.

Blue WH, Red Congress: Aggressive Fiscal Consolidation

• Tariff and immigration remain status quo.
• Congress enforces 4ppt of GDP reduction in the budget deficit.
• Growth slows below trend and inflation falls below target.
• The Fed cuts 250bp to 1.9%, comparable to pre-pandemic.

Market Consequences

The analysis below focuses on what could happen immediately (two weeks) after the presidential election.

US Rates

Despite the recent slowdown in the labour market, we assume economic data will hold up into the elections. The market is already pricing a fast policy normalization with the Fed cutting almost 75bp in the next two meetings and Fed Funds priced to be back to 3% in September 2025.

Accordingly, we think the immediate implications of a Trump victory will be a bear steepening. This is because the market will immediately price a more expansionary fiscal policy mix (higher spending and tax cuts), together with the imposition of tariffs, tighter immigration controls and ultimately higher inflation risks.

The curve move will be more pronounced with a red WH and Congress as markets will perceive this as the most inflationary scenario. Markets will not price 2025’s potentially negative implications for growth in the election aftermath. Instead, we think markets will price the policy mix as more supportive for growth with a red WH and Congress than with a red WH and purple Congress. This is because it could take longer to get the more expansionary fiscal policy mix in the latter case.

With a blue WH and blue or purple Congress, we think the rates reaction will be more muted. This is because the market will likely price budget, tariffs and immigration policies to remain roughly unchanged, limiting implications for growth and inflation.

In this scenario, which could be also called ‘Fed SEP’, we could see an immediate rally in rates – maybe more pronounced in the long end. Yet after two weeks, we would not be too surprised to see rates broadly unchanged with no substantial curve move.

Meanwhile, particularly in a blue sweep, we see a nonzero chance that rates could drift higher. This is because markets could immediately price a negative budget deficit given there will be no tariffs offset of any kind.

Finally, with a blue WH, red Congress, the market could price a more aggressive fiscal consolidation with a larger negative impact on growth and inflation causing rates to rally.

FX

As the table above highlights, we expect knee-jerk effect of a stronger dollar under a red WH and weaker dollar under a blue WH. This is because a red WH would be associated with higher risk of import tariffs and less easing by the Fed, while a blue WH would be associated with status quo.

The magnitude and dispersion of the dollar move would depend on the configuration in Congress.

We expect dollar to be strongest in a Republican sweep (scenario 1). MXN would likely bear the brunt, as Trump’s agenda of mass deportations and tariffs would have a high chance of being implemented. Export-oriented Asian currencies would likely fall as well. Under scenario 2, where Trump wins the presidency but Congress is split, we expect modest USD strength and with similar distribution.

In contrast, USD should be weakest in a blue sweep. This scenario would see little impetus to narrow the US’s twin deficits. As such, cyclical currencies like Asia and commodity currencies could benefit the most. MXN would probably enjoy a relief rally as well.

Finally, under scenario 4 and especially 5, we expect policy gridlock leading to greater fiscal consolidation and more pressure on the Fed to cut. Under these scenarios, USD weakness could be more concentrated vs JPY and CNH.

Equities

The outlook for equities is the most uncertain. Any result could likely deliver a rally initially as uncertainty leaves markets. However, we think the initial reaction will favour a Trump victory.

This is because the prospect of additional tax cuts and the extension of the TCJA will likely be the market’s first area of focus. We agree with the consensus that the expiry of the TCJA could result in a 5% decline in EPS, as the corporate tax rate rises for US corporates. Therefore, a removal of this possibility is positive.

There are likely to be secondary impacts as well. The winners of Trump’s victory are likely to be companies and sectors that benefit from his policies. We name a few here:

Winners:

• Border control: Private prisons and domestic security.
• Deregulation: Regional banks.
• More M&A among small and medium-sized firms: Smaller investment banks.
• Reduced regulation in energy production: Oil drilling and services firms.

Losers:

• Higher tariffs: China-sensitive baskets.
• IRA repeal: Clean energy sector.

If Harris wins, the initial outcome is more likely to be negative on the prospect of higher corporate taxes. We expect stocks to decline 3-5% following the result. However, this could be balanced against a more certain backdrop with stronger growth. The Democrats also plan household tax credits for the middle class to boost consumption; this may lead to retail sector outperformance.

Finally, if both the House and Senate turn red amid a Harris presidency, clean energy stocks should underperform as the chances of an IRA repeal rise.

Commodities

Commodities should see less election impact due to dependency on China for demand growth. Yet if Trump wins, we watch a few areas.

First, we think gold could benefit as the prospect for higher tariffs and increased sanctions rises. This could accelerate foreign CB gold purchases over the next 12 months.

Second, we see PGMs (platinum and palladium) being marginal beneficiaries if the IRA is repealed. That is because fewer subsidies for EVs will likely lead to increased demand for ICE and hybrid vehicles. The loser from this is likely to be copper, as we see lower demand for EVs and solar installations.

Therefore, we see long PGMs and short copper as being our preferred trade in these scenarios.

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(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)