by Nannette Hechler-Fayd’herbe, Chief Investment Officer – International Wealth Management, Credit Suisse.
Market sentiment has turned risk-off on the heels of news that US President Donald Trump and First Lady Melania Trump have tested positive for COVID-19. For financial markets, it remains key to focus on the upcoming US elections and the outcomes that are relevant for US economy policy. We believe that a sweep is now more likely than a split Congress and expect the Senate and the House of Representatives to swing to the party of the presidential election winner.
Following news that US President Donald Trump and First Lady Melania Trump tested positive for COVID-19, financial markets have reacted with a risk-off move. Equities are down, equity volatility is up, and safe-haven assets like the JPY and US Treasuries are well-bid. While this move may reflect initial caution in the face of potential risks around the US president’s health, it more likely serves as a wake-up call for financial markets to expect a seasonal reacceleration of COVID-19 infections around the world. What can happen to the US president can happen to the population more broadly, with the potential disruptions to economic activity that this may entail. The news puts market focus on the likely roll-over in economic data and momentum in Q4 after the encouraging developments of Q3. So, we expect risk assets and cyclical assets to continue to fluctuate in sync with the public health situation, vaccine-related news and their respective implications for the economic outlook in the months to come.
US elections
Donald Trump’s positive COVID-19 test will likely see the campaigns focus more sharply on the handling of the coronavirus pandemic. For now, Democratic presidential candidate Joe Biden has remained consistently in the lead over Donald Trump in national polls, and this may persist. While Donald Trump’s campaign rallies will likely be disrupted, the effect of such disruption will depend on the actual state of his health. A relatively mild symptomatic course of illness and rapid recovery could eventually be positive for him in swing states. Health complications, however, would be detrimental. The Democrats have yet to determine how to conduct their own campaign in the face of this development and whether to expect a freeze of some sort in campaigning while Donald Trump is in quarantine.
In any event, the electoral outcome will boil down to what happens with the electoral vote of swing states. Based on the ranking of swing states by the Democrat-Republican lead in presidential polling, we estimate that it will be the electoral votes of Arizona and Pennsylvania that will likely tip the balance. Our base case (40% likelihood) is one of a Democrat sweep, with a presidential election victory by Joe Biden and the Democratic Party achieving a majority in both houses of Congress. The alternate case (35% likelihood) is a Republican sweep with Donald Trump winning a second term and a Republican majority in both houses of Congress.
US fiscal package and outlook
Democrats and Republicans have remained far apart in their stance on the size and focus of a next fiscal stimulus. The House of Representatives has approved a package worth USD 2.2 trillion, far above the White House’s proposed USD 1.6 trillion. It seems unlikely that a breakthrough is achieved before Congress goes into recess next week. But talks seem to be continuing between House Speaker Nancy Pelosi and Treasury Secretary Steven Mnuchin. Should a rapprochement be achieved, Congress may still be called back to vote on a bi-partisan package before the 3 November election. Otherwise, the prospect of an election sweep increases the chances of a stimulus package to be passed after the election.
Markets may find solace in this, but the long-term prospects for the US equity market, the USD and oil prices will very much depend on whether the election results in a Democrat or a Republican sweep. A Senate and House of Representatives under the same political party majority would indeed pave the way for more decisive left-leaning or right-leaning economic policy. In a Democrat sweep, we would expect tax policy and regulation to be less positive for US equities, but the USD to be less weakened and oil prices – counter-intuitively – to be supported, as US oil supply would likely decline amid a push toward clean energy. In a Republican sweep, tax policy and regulation would likely be positive for US equities, but the USD would likely be weakened more as the fiscal situation of the USA would likely worsen. Oil prices might be negatively impacted if oil supply in the USA is increased as a result of government policy, though capex is set to remain constrained. Trade policy would most likely keep a protectionist spin regardless of the political landscape in Congress and the White House. We remain comfortably neutral on equities in a multi-asset strategy and portfolio context. Investors who are underinvested in equities should use sell-offs as an opportunity to build equity positions.