The US election outcome was not the decisive landslide that Democrats had hoped for, once again demonstrating the failure of pollsters to capture the true extent of populist momentum. President Trump’s performance exceeded all expectations and he further consolidated power in his strongholds of Florida and Ohio. Uncertainty around the final outcome remains relatively high, though betting markets are now firmly in Vice President Biden’s favour after a volatile 24 hours.
Timing of a final resolution could take anywhere from today to the extended time frames described in our previous US election tail risk analysis that stretch into the new year. If the decision comes down to Pennsylvania, we may have an answer in a few days. However, if Trump follows through on his announcement to advance his case to the Supreme Court, we may be looking at weeks or even months of uncertainty, with the Electoral College deadlines of 8 and 14 December drawing a bright line between an orderly resolution and a potentially highly-fraught negotiation across a divided Congress.
Which brings us to the Senate race. Here, the Democrats fell far short of polling expectations with only one of seven potential flips under the belt and the remaining races appearing very close. Chances of a divided Congress are much higher than they appeared before the polls closed.
This suggests that the opportunity for a potential Biden administration to push through transformative fiscal spending in excess of $5 trillion over the next four years is slipping away. Barring a shocking reversal of fortune in the Senate races, Democratic ambitions will be constrained, with an implied four-year spend of $1.5 -2.5 trillion (gross and net), weakening growth prospects for the US economy.
Downside risks to US growth as fiscal prospects weaken sharply
A split Congress scenario implies much lower fiscal spending over the next four years relative to policy expectations under a Dem sweep. In terms of immediate implications, we would expect a COVID relief package of less than $1 trillion some time in H1 2021.
Against the backdrop of another virus wave, this is unlikely to be enough to maintain strong economic momentum into 2021. Our estimates suggest that total stimulus of around $2 trillion, which (in addition to the COVID relief) would include other measures such as infrastructure spending, could add around 1.5 percentage points to GDP in 2021
This in turn implies the COVID-induced output gap is unlikely to close before 2023 under a split Congress, independent of who takes the White House. On the flip side, under a Republican Senate majority, no major tax increases would be likely, which could help growth in the medium term, but which would also significantly raise the sovereign debt burden in the longer term.
Before the stimulus package is enacted, we see a very low probability of any significant 'bridging' measures which would continue supporting incomes in the meantime. This would in turn pose significant downside risks to consumption and consensus growth estimates of 4 per cent in Q4 2020 and 3.7 per cent in Q1 2021 (in qoq annualised terms).
At the same time, the virus trajectory, associated mobility restrictions, prospects for outpatient treatments and vaccines also remain key to the outlook for the economy and markets. Stricter restrictions - which would be more likely under Biden - would deal a bigger blow to activity assuming more limited fiscal support to offset it.
Fewer restrictions on social distancing and mobility - which would be more likely under Trump - could help avoid significant growth slowdown through the winter. In either case, vaccine approval, and its early and effective rollout, would deliver the biggest positive risk to growth over the next few months. We remain sceptical about the possibility of fast vaccine deployment as early as Q1 which would allow significant relaxation or even total removal of restrictions, but this is an upside risk that deserves monitoring.
Back to “the only game in town” and more Fed easing
What exactly the Fed decides to do would largely depend on the financial conditions and economic data over the next few weeks. Ensuring smooth market functioning via existing tools would be the short-term policy priority. In the absence of a large fiscal impulse, it will be even harder for the Fed to generate a sustainable rise in inflation, which would call for further policy easing.
Action in December is more likely than in November, given the current election uncertainty. In addition to switching to buying longer duration bonds, the Fed might have to increase the pace of asset purchases and strengthen forward guidance to help mitigate the impact of the impending fiscal cliff.
Volatility ahead, especially without resolution before 14 December
In terms of market implications, under a contested election scenario, uncertainty would likely be an important driver, potentially well into January. Here, a lack of resolution before 14 December could intensify volatility in markets.
It is interesting to note Wednesday's market action, with a strong rally in government bonds and US tech signalling re-pricing of cyclical and reflation trades, which had been in play over the last few weeks as a “blue wave” started becoming the base case for markets. At the same time, the US dollar (USD) has been volatile, reflecting overall uncertainty.
As we look past the resolution period, however short or long it is, we expect US equities to be range-bound to modestly higher (assuming that the situation is resolved before 14 December), with weaker rotation into cyclicals and value for now.
Beyond the next few weeks, the impact of smaller fiscal support and continued accommodation on the monetary side would be neutral to somewhat positive for US government bonds. Credit does seem to be a stronger beneficiary in the event of further monetary policy easing. In the FX space, USD should remain supported in this environment, at least until there is more visibility both on the elections and the battle against COVID.