US Election: A pre-postmortem on the prospect of US gridlock
Head of FX Strategy
Summary: The final US election tallies await, but are pointing to Biden winning the Presidency, with Trump clearly set to go down fighting. Elsewhere, the last gasp shred of a hope for Democrats in the Senate likely hinges on a miracle in run-off elections in Georgia in January. In the meantime, we look at some key questions for markets in the days and months ahead.
The polls were very wrong nationally and in some spots, but very right in others.
During Election Night, once the majority of results rolled in from Florida and clearly showed that Trump was set to take the state and by a larger margin than he did in 2016, I was bracing for an across the board shocker on high risks for a Trump win. But the grand irony of the night was that Florida – the “ultimate swing state” and the best one at counting and quickly reporting its early and election-night results, proved to be utterly mis-leading as it had one of the most pronounced shifts to Trump of any state in this election. Few would have thought it even conceivable that Florida could double its margin in 2020 in the Republicans’ favour relative to 2016, while Georgia, which went to Trump by 5 points to Trump in 2016, looks to be within 0.5% in 2020.
As the night wore on, the blue shift in many states relative to 2016 did in fact emerge, so the polls were directionally correct in aggregate, if still very wrong in places like Wisconsin and Iowa. But the fact remains that something is desperately wrong – and increasing in degree – with the quality of the polls produced by mainstream polling outfits. The polling error at the national level will in the end prove at the very far end of the supposed margin of error and possibly beyond (Biden winning national popular vote by 3% or so instead of 8% or higher). The chief takeaway for market participants is to maintain a very wide margin of polling errors until the pollsters show signs of getting it more right by changing their methods. As well, balancing the polls against things like enthusiasm for individual candidates’ base and “the narrative game” I mentioned in my piece at the weekend.
The outstanding drama focuses on four states
Things will undoubtedly change rapidly both today and in the coming few days, but the paths to a Biden win from here are many and for Trump very few. The drama focuses chiefly on four states: Nevada, Arizona, Georgia and Pennsylvania (assuming North Carolina is a lost cause for Dems). Arizona is theoretically still in play for Republicans, even if some news outlets have called the state for Biden. If Biden does lose Arizona, he will have to pick up either Georgia or Pennsylvania (which is seen as a certain to fall his way), while even if Pennsylvania hangs around in limbo on legal challenges, if Arizona does go to Biden, he only needs to retain Arizona.
The Senate window for Democrats almost entirely closed
The Democrats’ path to taking the Senate has just about been eliminated. Of the final four seats up for grabs, Alaska will go Republican, the lead in North Carolina for the Republican candidate looks insurmountable. That leaves two Georgia Senate seats where there will be a run-off in early January. Both of these would have to fall into Democratic hands to get to the 50-50 Senate needed to allow minimal Democratic control (with VP Harris as the deciding vote) Thus, it appears nearly certain we will have political Gridlock at least until the 2022 US mid-term elections that prevents the more generous fiscal stimulus that was seen likely under a Blue Wave outcome. More on that below .
Besides the results-on paper, where to focus from here
The quality and narrative of this pronounced knee-jerk market reaction
The first order of business is framing this incredible market reaction that has materialized despite Trump hotly contesting the results and the prospects for two years of ugly political gridlock. Equities and bonds have gone almost vertical since Election Night. We discussed this in today’s Saxo Market Call podcast, but the most likely immediate driver of the action could simply be that the market has put on excessive volatility hedges on the election uncertainty, and that the unwinding of these hedges (despite the outcome) means the need to unwind short equity futures and short US t-bond futures contracts. Other less obvious contributions to the enthusiasm are that the avoidance of the Blue Wave scenario means we avoid any corporate tax hikes and possibly much lower inflation risks on the short fall of stimulus. Further down the road, one has to wonder if risk sentiment on the outlook could quickly be tempered or worse after this initial relief trade on the risks to growth on lower stimulus prospects and economic scarring from the Covid-19 crisis. Yes, the Fed will try to do more at the margin, but monetary policy is weak medicine compared to fiscal policy at the zero bound. Much more below on the political gridlock implications.
How long will Trump hold out?
Trump is already taking aggressive action and his communication with his base is that the Democrats are outright stealing the election, which no doubt many of them either believe, or don’t care if it is true or not, they just want Trump to stay in office. Civil unrest and random incidents are an overhanging threat with each passing hour.
But fellow Republicans are likely the eventual key in seeing Trump forced to concede. Many of them have been uncomfortably beholden to Trump via his raucous base, which has prevented them from doing anything save going-with-the-flow while he was president. But if there is no viable credible legal challenge of the election results, they will have to essentially decide whether they are in favour of what amounts to a coup d’ètat against the legally elected Joe Biden and his likely 4-5 million popular vote superiority in the national vote, or to joining arms in asking Trump to step down. Protests on the streets and ugly confrontations are days away if Trump doesn’t back down and risks will accelerate with every passing day.
Is the Fed the savior no matter what?
Some would argue that with Washington gridlock holding back fiscal stimulus potential for at least the next two years, the Fed can offset the downside risks by going ultra-easy. But what can the Fed do from here besides increasing the pace of QE? Any demand side effect would require the Fed to step outside of its mandate and innovate in ways never intended and be highly politically charged. The Fed’s backstopping of the system is already nearly total and actually increases the risk of zombification, weak growth and moral hazard from here. More of the will prove increasingly counter-productive in the long run. Rather, fiscal is the only way to more powerfully address the demand side of the economy and offer a path to reflation, even if it brings with its own set of problems.