US elections: Market volatility ahead
Investors have been preoccupied with the UK’s EU referendum and prospects for another Fed hike in coming months. Once these events pass, we expect a growing focus on the US presidential elections.
The presidential election markets may be underestimating the likelihood of a Trump presidency.
While Secretary Clinton has a demographic advantage, Trump may have various paths to victory.
If he can expand Romney’s electoral map with a combination of wins in the swing states, he could reach the majority of the electoral votes.
If Clinton wins, the market effect should be muted.
Such an outcome is expected and would probably maintain the status quo as she would likely face greater political gridlock.
A Trump victory should be a market event, as Republicans would likely also have control over the Congress, allowing for ambitious legislative changes.
Despite the hype, the election itself have not been key drivers of macro returns historically.
Rather, returns are driven by evolving expectations of the economy and business cycle, which are often at turning points around elections.
If Trump wins, after any initial hiccup, the 10- year US Treasury yields are expected to rise.
Prospects of easier fiscal policy should lead to a repricing of the expected path of short rates.
Higher fiscal and inflation risk premia would also raise the premium term.
Such a move in USTs would undoubtedly spill over into the global rates markets.
With monetary policy perceived to be reaching its limit, the extent to which fiscal policy enters the toolkit will be the key driver of expectations.
If Trump followed through even partially on his stated fiscal policies, it could provide a short-term boost to growth, potentially extending the business cycle.
Greater globalisation, immigration and central bank independence have helped keep inflation in check over the past few decades.
If these trends are at risk of reversing, which would be more likely under a President Trump than Clinton, it would raise inflation risk premium, mostly affecting the long end of the curve.