Let us be clear, the state of the Union is not strong. Following the US Supreme Court ruling in Donald J Trump vs the United States, the US President now has a blanket immunity from prosecution for crimes committed in an official capacity and a presumption that most public acts are in an official capacity. There is also an injunction against using official acts as evidence in cases where the crime is not an official act. (A list of countries that have similar provisions is here.)
The scope of power for the US president is altering dramatically just as the US sets out to vote for its next President. This has massive ramifications for the world at large, but also immediate impacts for investors. This piece will seek to explain how we got here and what might happen in the various scenarios for the November 2024 US Presidential Election.
In short, the likely outcome is a bond market rally on the re-election of Biden, but a sell-off on a second Trump Presidency. We think markets will respond to Trump’s pro-business stance and inclination to cut taxes. In the longer term, the risks to the US system are material – though not all those risks have direct market connotations and in fact many don’t. Just as a healthy democracy is not a guarantee of strong growth and strong markets, nor is the absence of healthy democracy a guarantee of near-term economic stagnation. It’s not great in the long term, though.
The History and the Landscape
While the decision on presidential immunity was a major waypoint for the retreat of democracy in the United States, the overall trajectory has been poor for some time. The Brookings Institute points out that anti-democratic actions have been the norm for the last 15 years. This backsliding comes about in part because many have lost faith in the system and no longer care to defend it. Over the last 40 years, real GDP per capita in the United States has more than doubled, but over the same period, the real weekly median wage has risen 8%. The populace is losing faith in the political system because the political system cannot legitimately claim to be serving the will of the people.
This long-term problem shows why the US political fabric is slowly being unwound. Far too few are invested in seeing the current situation continue. More and more outlandish (and simplistic) solutions become attractive to the population at large because continuing the status quo is unacceptable. We liken the current situation in the US at present to the UK leading up to Brexit. That’s a cautionary tale – both because the “Remoaners” who warned about the immense damage Brexit would do to the UK economy were right, with hindsight, but also because Remain lost the referendum anyway. (Between 2016, when the Brexit referendum occurred, and 2023 the UK GDP per capita has grown 3.8% in total compared to 11% for the EU as a whole.)
For the US, the lack of performance by the current political system results in hyper-partisanship, which in turn creates the risk of large policy swings. The result of the Presidential election in 2024 will have a massive bearing on how the US government looks in 2028 and beyond. That matters for long-term investments like bonds.
Oddly, for such a consequential election, neither candidate is strong in a traditional sense. It is very hard to see either winning the presidency in the 1980-2000 period (in fact, both tried repeatedly and failed in that period before eventually winning later). This suggests that neither candidate will move to a commanding position before the election.
Markets up to the election
With such large swings possible, we’re expecting to see tumultuous headlines. But we don’t think it is likely that either candidate will move to a position where the result of the election looks clear. That will likely lead to volatility in a daily sense, with sharp moves on any given day a clear possibility.
However, while the overall outcome is unknown, we believe markets will remain range-bound overall. Until we know the outcome, most traders will be reluctant to take large positions. We’re expecting a wild ride that doesn’t break materially in either direction until after the election.
What happens if Biden wins
For this scenario, we assume that a Biden Presidency comes with a divided government. In any reasonably close election overall, the Senate is likely to be won by the Republicans. The situation in the House is a bit more mixed and the Democrats could win there on a solid Biden victory. Only if Biden were to completely crush Trump would Democrats win all three branches.
The result of that divided government is mostly a continuation of the current policy, but that’s not without risk.
US Debt/GDP and deficits are already large and, without a clear mandate and with a divided government, it is hard to see that changing much overall. Biden will likely attempt to increase his spending policy along the lines of the Inflation Reduction Act, but it’s not clear he will be able to.
Compared to other scenarios, this is less dangerous in the short term, but things could get difficult if there is a material slowdown in growth. If that happens, the rising deficit from falling taxes may see US debt/GDP ratios and deficits rise into more dangerous territory. We doubt there would be a full UK/Liz Truss style reaction, but the underlying risks are similar. Debt cannot grow without limit; eventually debt markets start to react and sell-off, or economic growth starts to stagnate.
Most likely market outcomes of a Biden victory:
We expect a small rally in bonds as the risk of serious misadventure like a disputed election is avoided.
Equity markets may fall, as Democrats are seen as less friendly for economic growth in the short-term. That would also add to the bid tone for the bond markets.
In the more medium-term, we would watch for signs of steepening of the 10Y/30Y bond slope. That’s where market concern about the level of debt overall would start to show.
What happens if Trump Wins fair and square
For this scenario, we assume that Trump gains the Presidency by getting more electoral college votes and winning the election. If so, he almost certainly gets a unified Republican Government of Presidency, House and Senate, thanks to the structure of the US states and congressional districts.
We would expect a much more aggressive and early change in policy in a potential second Trump term than in his first. In 2016, the Trump transition team seemed to be slightly naïve and didn’t fully understand how the levers of power worked. That is unlikely to happen again and they are far more likely to start implementing their policies on day one.
Trump, it is often said, should be taken seriously but not literally. Implicit in his slogans of “Drain the Swamp” and “Make America Great Again” is the promise that Trump will break the system in order to completely remake it. This threat – this promise – motivates some and reviles others in near equal measures.
Those who want to “Make America Great Again” see that US politics is not, and has not for a while, been serving the greater preferences of Americans. We doubt that the changes Trump proposes will actually help the fundamental problems like wage stagnation or inflation. In fact many of Trump’s stated policies will actively make the problem worse, in our view. For example, a 10% tariff on all imports doesn’t help lower inflation. But, we can also see what is motivating many to try a new path.
In the short run, the economy could look quite healthy at the start of a Trump second term. Early in his second presidency, Trump likely passes some form of material tax cut for wealthy individuals or corporations, or both, which will serve as a sugar-hit to the economy. Furthermore, Business regulation is almost definitely lighter under President Trump. It’s also likely that carbon policies are laxer and fossil fuel extraction is higher. These results are positive for market optimism in the short term and are obvious nearly immediately.
The rest of the world may take a Trump victory as a bad sign, but the US is not likely to. Not least because around half of voters, or more, will have voted for him if he wins.
However, the medium and longer-term risks are more dangerous.
In the medium term, the deterioration in global cohesiveness already apparent likely worsens. A split between the US and Europe is also quite plausible, with the Ukraine War and the policy towards Russia a key flashpoint.
The combination of these lead to greater inflation and lower productivity, globally, as the Trump term progresses.
In a Trump victory there is a material risk the US becomes markedly less democratic – note the small ‘d’. There have been clear signs of voter suppression tactics in the US and suggestions Trump would retaliate against political foes is not a hallmark of healthy democracy. That move is damaging in the long run. “Democracy is the worst form of government – except for all the others that have been tried.”
Reducing democracy in America probably leads to lower economic growth and lower productivity over time. At present, the US benefits as a destination for the world’s best and brightest. That could well change directly under Trump’s migration policies, but also indirectly as the tone of US polity becomes less attractive for international migration.
Most likely market outcomes of a Trump victory:
We would expect a risk-on move including an equity rally and bond-market sell-off if Trump wins. The short-term boost to business confidence and the likely tax cuts probably sees a rise in equity markets and a rise in bond yields.
In the medium-term, other themes are likely to develop. The early risk-on movement anticipating growth could easily become more of a stagflation response as productivity falls and inflation rises. The effect of those two on bond yields is harder to predict, since higher inflation tends to see higher yields, but lower growth causes lower yields. From this starting point, the increase in inflation is likely to be the most obvious effect. That suggests higher bond yields and lower bond prices, particularly for shorter-term notes and probably more sharp inversions of the yield curve.
A reduction in democracy in the US is not clearly good or bad for markets in the short-term. Plenty of non-democratic countries have had strong economies for long periods of time. In the long run, the lack of accountability tends to result in weaker economic growth, but that can take years or decades to manifest.
What happens if there is no clean winner, and the election is resolved via the Courts, or violence, or both
This is not a likely outcome, but it is depressingly plausible as the events of January 6 2021 attest.
In a contested scenario, the most likely outcome is a Trump Presidency. The Supreme Court’s conservative majority is very clearly favouring Trump (after the immunity decision there can be little doubt). Furthermore, various constitutional clauses allow the House of Representatives power to step in and choose the President in contested situations. As we noted above, in any close election the House of Representatives is likely Republican.
A contested election resulting in a Trump presidency is less likely to be taken as good news for the economy in general since there is a much greater sign of weakening of institutions, which will spook markets. In this scenario, you probably get a much larger international reaction that tempers any enthusiasm for Trump from inside the US. The worse the turmoil, the greater the chance that bond yields, globally, fall and prices rise.
Should Biden prevail in a violence-marred election, the result will be more damage to the US’s global standing. That probably adds to the bond rally we see as the likely response to a Biden re-election in a clean election.
No matter the scenario, the implications of the coming US election will be felt far and wide. We expect considerable volatility in markets until the election. A re-election of Biden continues the status quo, more or less, and probably sees bonds rally. An election of Trump probably sees a sell-off as Trump is seen as more positive for the economy in the short-term. The longer-term costs may be dear, however.