US Election Countdown - It’s all about the senate race
Australian Market Strategist, Saxo
Summary: Rebalancing of both equities and bonds was the story last week with the resurgent pandemic and looming US election. Risk sentiment this week will again be governed by the election, the VIX index is back above 30 and markets could be prone to big swings. With no deal reached on the next round of US fiscal aid prior to the election, its all about the Senate race and the timing/size of more fiscal aid.
As Donald Trump and Joe Biden head into the final campaign sprint, election odds have narrowed but importantly Biden has never slipped behind in any of the swing states that are likeliest to decide the election.
However, nothing is a given. Election day could still be overwhelmed by in person votes for Trump who has drawn huge crowds across Pennsylvania, which could be a crucial swing state. Analysts have also pointed to “shy” Trump voters evading pollster’s as just one factor in why polling still in 2020 may not have captured the reality on the ground.
The election outcome is hard to predict with certainty. There is such a divisive human element in today’s hyper-polarised society and turnout is the swing vote. Whoever can mobilise non-voters to return their ballots has an innate edge. These factors mean there has been very little appetite from investors to add to positions as uncertainty runs high and election polls show a tightening race.
With less than 5 days to go until one of the most divisive elections in recent history, anticipation is rife, and markets have been in de-risking mode ahead of what could be a volatile week, or even month if the result is contested.
The polls could be as wrong as 2016, or even worse as wrong as 2012 – both scenarios holding very different implications. But even if the polls are as wrong as 2016, Biden’s predicted lead is so significant that he still wins. And a 2012-esque polling error could see an even larger blue sweep. But this year the COVID-19 pandemic, resurgent virus case load and faltering economy add another layer of uncertainty and as such, scepticism surrounding the reliability of polling remains.
This elevated uncertainty means volatility will remain until there is a clear outcome on the Presidential race. The bottom line be prepared.
So, what to make of it all? There are a number of reasons why the presidential race will have implications for risk assets, but in our view the most consequential is the fact that the US economy is in need of another round of fiscal stimulus. Gridlock in congress has seen no deal reached prior to the election, pushing the prospects of more aid out as far as next year.
Both Trump and Biden would spend big – one prints to spend, the other taxes to spend, either way there would be a large aid package incoming. This is why the Senate race will be crucial in determining the timing and size of another round of aid that the US economy so desperately needs with benefit cliffs fast approaching.
The Senate has been adjourned until November 9 and there is no one left in DC to pass a stimulus bill. Now the only way a package is passed prior to the 20 January inauguration is if Trump wins the presidential race. A big spending package will support the US economy and markets whoever is President and fresh of the win, Trump (no stranger to spending big) could bully Senate Republicans into reaching a deal on stimulus and push a package through congress before the end of the year.
Post the election, if Trump loses, and further if Republicans lose control of the Senate it is unlikely that a deal will be reached on additional aid, with no incentive for the Trump administration to corral Senate Republicans (Mitch McConnell and the fiscal conservatives) toward a deal.
This leaves the stimulus impasse open until February 2021 in the best-case scenario, and worst case, even later if the Republicans retain control of the Senate and any package eventually agreed upon would undoubtedly be a lot smaller. The ability for markets to “look through” the current stimulus gap is then all down to the senate race, which will be a key directional driver for risk assets post the election.
All about the Senate for fiscal
All eyes will be on the election, but the Senate race holds the most answers for risk assets.
The biggest read through on Wednesday will come from the Senate composition and as most of the Senate battleground seats are in states that have timely results the prospects of fiscal aid should become clear come Wednesday.
A Democratic House and Senate likely becomes the most risk positive scenario as post inauguration (20 January 2021) there will be a much larger reflationary fiscal package passed – This certainly the consensus narrative. An undisputed blue wave would see big spending plans boosting economic growth and supporting share markets. In that instance, it is likely markets can “look through” the stimulus gap.
The hope trade is always laced with complacency, however confirmation of a larger fiscal package come February with a Democratic House and Senate, alongside the supportive monetary policy regime that remains omnipresent, should allow risk assets to look ahead.
This outcome is still far from guaranteed – A big unknown is Biden’s tax policy and any progressive left agendas. Will the changes make it over the line? And if they come after a big spending package and tariff wind back, could that boost to the economy offset the implications of tax hikes? There is uncertainty on how equities reflect the risk of higher taxes. Another unknown is the COVID-19 response plan. On the health front, a more comprehensive testing and tracing system would be a positive for containing the virus spread but a Biden administration may have a higher propensity to apply tighter government restrictions and lockdowns which would be negative for share markets.
Turnout is already unprecedented in some States, and few turnout to keep the status quo. Personally, I think that Biden will win the election with a large enough majority to quell the probability of a contested result.
It’s a “now or never” election for the younger demographic. A national poll of Americans ages 18 to 29 from the Institute of Politics at Harvard Kennedy School found that enthusiasm for voting in 2020 is on par with 2008, a historic election for youth turnout. The 2018 mid-term elections had highest turnout of any mid-term election held since the 1914 elections. Participation was especially high among young people who voted overwhelmingly in support of Democratic House candidates.
In 2016, there was only 2.7mn Generation Z voters. This number has swelled to 24mn in 2020. Generation Z are far more racially and ethnically diverse than their predecessors, with a larger minority population than any other generation. They are more progressive and attuned to social issues like diversity, gender and racial justice and fighting climate change. Statistics show they care less about upholding traditions, religion and nuclear families and more about systemic racism for example. Not a recipe for a GOP vote!
The youth vote provides a crucial swing factor for a Biden victory, not necessarily because Biden’s platform provides a strong vision for the future, but because those who have “lost their voice” with respect to climate action, principles of democracy, diversity, and international cooperation, galvanised by the anti-Trump vote, turnout in force, particularly the progressive youth.
This against the backdrop of a concentrated effort by social media networks to re-energise younger voters, where green policy, education and social issues like racial equity, inequality and gun control are huge drivers for this cohort. The rise of this generation will signal a turning point in US politics, with a seismic generational shift in power underway. A shift that must reshape the future values of the Republican Party with time if they wish to remain competitive.
If this scenario takes place, the reaction on election night could be quite strong; many investors and traders remain sceptical after 2016 polling debacles and a blue sweep is not yet fully reflected in positioning.
However, if the GOP retain control of the Senate, this would be a big setback for the reflation trade, souring sentiment. Particularly with the virus on the rise once again. Even if Biden wins, the WH will be hamstrung with a Republican Senate majority until at least the 2022 mid-term elections. A lack of fiscal support and little prospect of a big package even after Biden’s inauguration in January coupled with rising virus cases could become quite negative for risk assets. A silver lining would be unchanged tax policy and a more collaborative foreign policy stance with the possibility of tariffs on Chinese imports being wound back which would be supportive for investor sentiment.
Moreover, if delays in approving fiscal relief for the COVID-hit US economy weigh on consumer and business sentiment this could see the Fed implementing an expanded QE package to support the recovery come December. The Fed will keep policy steady this week immediately post the election, but will be contemplating further policy easing, particularly if fiscal stimulus remains absent.
This is why, outside of the contested election scenario, the Senate race (not the White House) is where risk assets will take their cues.
The contested result
At present, markets are expecting volatility to stay elevated for at least one month after the vote. This is because of the higher probability of a contested result, with accusations of mail-in ballot fraud and delays in counting ballots. Several battleground states cannot even begin count their mail-in ballots until election day. Unless the polls are right and turnout for the Democrats can drive an obvious, irrefutable landslide on election night that sees Republican support for contesting the result dry up, the probability of a contested result remains.
Officials are already warning that the result may not be known for days or even weeks due to the surge in postal ballots. For example, in Pennsylvania the National Guard is on standby to manage any upset and officials are warning voters that they should not expect Pennsylvania to be called on election night.
American democracy is not at its peak
Trump has already vowed legal challenges on the night of the election and investors are gearing up for what could potentially be a long wait until the result is known. And the supreme court, with its newly improved conservative majority, will be adjudicating.
A contested result, the worst-case scenario, could change market dynamics very quickly. If this scenario unfolds, a longer period of uncertainty emerges - expect more volatility, but don’t panic. When Democrat Al Gore contested George Bush’s appointment in the 2000 Presidential election, it took 36 days before a winner was declared and the share market fell around 10%. This year’s election could come with an even greater legal challenge if the results are close.
We are truly in unchartered waters. Gold could provide some refuge for investors in this scenario, but initially may be subject to some forced selling if share markets drop. Volatility can also be an opportunity to look for opportunity, particularly amongst high quality stocks that have been indiscriminately sold off.
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