Have you been following the USA Elections?
It’s been one of the nastiest and most negative we’ve ever witnessed.
As we approach the final stretch of the US election we thought it would be timely to share an article from Colonial First State Global Asset Management’s Chief Economist, Stephen Halmarick.
To say that the 8 November US election is one of the most important – and divisive – in recent history would be an understatement.
The most recent opinion polls for the Presidency range from a tie to a Clinton lead of 12 points, with the average around five points. This is enough to give former Secretary of State Hillary Clinton the win – and most economists and political analysts I met in New York and Washington are assuming this outcome. This conclusion comes with a warning, however, and that is that many people (including some very experienced political analysts) have been underestimating Donald Trump for over a year – and he continues to defy his poor expectations.
The opinion polls also show Hillary Clinton with a net favourability rate of -9.4 points. This is not a great rating – but certainly better than Donald Trump’s -25.2 points. Interestingly, President Obama is coming to the end of his eight years with an approval rating of a relatively high 51.8% – and this should help Clinton.
Nevertheless, as was the case with the ‘Brexit’ vote, the opinion polls could be misleading and there is a concern that the markets and the media may be underestimating the power of Donald Trump’s ‘the system is rigged against you’ message. Trump supporters generally feel like things need to change – but they are not sure of the specifics.
Despite this caution, the general consensus in the US is that a Clinton victory is around a 75%-80% probability. So I have assumed that Hillary Clinton will win the election and be sworn in as President in January 2017 and all of my economic and financial market forecasts are based on this outcome. However, the race is still yet to be run and won.
Importantly, what the national opinion polls do not pick up is the way the Electoral College system works. The President is not decided by the national popular vote, but by who gains at least 270 Electoral College votes out of the 538 electors. Each of the 50 states and the District of Columbia are awarded a specific number of electoral votes based on the number of seats apportioned for the House of Representatives (which is based on the state’s population, updated by the census every 10 years) plus two votes for US Senators. For example, California gets 55 electoral votes, being 53 representatives from the House and two Senators. A state that has only one House representative would, therefore, get three Electoral College votes. There is a strong sense in Washington that the way this system works greatly favors the Democrats and Hillary Clinton. Key states to watch on Election Day are: Colorado, Florida, Iowa, Michigan, Nevada, New Hampshire, North Carolina, Ohio, Pennsylvania, Virginia and Wisconsin.
This election will see 34 seats out of the 100 in the Senate up for grabs. Currently the Republicans hold the Senate 54-46. So to gain a majority in the Senate, the Democrats would need to win five extra seats in the upcoming election, although if Hillary Clinton becomes President, the Democrats would have a majority in the Senate on a 50-50 outcome as the Vice-President can vote to break a deadlock.
The current view in Washington is that the Democrats have a real shot of regaining the Senate, perhaps with a majority of just a couple of seats, i.e. a total of 51-53 out of the 100. It is important to note that a simple majority of over 50 is no guarantee of being able to pass legislation through the Senate.
The House of Representatives:
In the House, all 435 seats are open for re-election. Currently the Republicans have a majority in the House, holding 247 seats. So the Democrats would need to pick up a net 30 seats to reclaim a majority. The view in Washington is that this is highly unlikely.
So the base case for the election looks like this: Hillary Clinton as President, a Democratic Senate and a Republican House. As stated, this is the base case, but given the underlying uncertainty of this election (ie. Donald Trump’s many inconsistencies and unusual personal characteristics v Hillary Clinton’s issues with her email server and a general sense of mistrust), any number of outcomes are possible.
If Hillary Clinton wins the Presidential election, her priorities are expected to be:
- Tax reforms: this could include corporate tax reform, including lowering the rate to around 25%, but also removing a number of deductions, i.e. widening the base. There is also likely to be a lower repatriation tax rate of around 10%-15%. This package is expected to be roughly revenue neutral. Income taxes on wealthy individuals are likely to rise.
- Infrastructure: An infrastructure spending package of $US200bn-$US350bn over the next few years.
- Education: Increased spending on both higher ($US500bn) and early ($US200bn) education.
- Health care: A focus on reforms to Obamacare to try and lower the costs and improve the coverage.
- Immigration reform: Better controls and a focus on skilled workers, but with limited move on a path to citizenship for illegal immigrants.
- Trade policy: A modified TPP, with worker protections, is likely to be passed prior to the 2018 mid-term elections.
- Wages: An increase on the minimum wage.
- Other: Housing finance reforms, improved climate change regulations, sugary-drink regulations, paid family leave and financial regulations.
- It has been estimated that Clinton’s policies would improve the US budget position by around $US1.2 trillion over the 2016-2026 period.
As mentioned above, we have assumed a Clinton victory in our economic and financial market forecasts. Immediately after the election, a Clinton victory is likely to see a short-term rally in risk assets, ie. equities and credit, especially in those sectors of the market focused on international trade. In 2017, we also expect some form of fiscal policy easing, ie. dominated by infrastructure spending that should also be positive for the economy and markets. A Clinton victory should not alter the path of the Fed, with a rate hike expected in December 2016 and two further moves in each of 2017, 2018 and 2019.
In terms of her appointments, I was informed that if she becomes President, Hillary Clinton has promised much more diversity in her major job postings, including a large proportion of women and minority groups.
In this regard, the two key candidates for Treasury Secretary that I was told are at the top of the list are both women. The first is Lael Brainard, a current member of the Federal Reserve Board and previously the Under Secretary of the Treasury for International Affairs. The other is Sheryl Sandberg, the current COO of Facebook, founder of the Lean In Foundation and former Chief of Staff to Secretary of the Treasury Larry Summers. Another potential candidate is Mike Froman, the current Special Trade Representative and former Chief of Staff to Treasury Secretary Robert Rubin.
Interestingly, I was also told that Hillary Clinton was likely to ask current vice-President, Joe Biden, to take on the role of Secretary of State. This would clearly be a critical role for the 73 year old, who was first elected as a Senator in 1972.
It is also worth exploring the Republican side of the 2016 election. If Donald Trump was to win, his policy priorities are expected to be:
- Tax reform: including a substantial reduction in both income tax (down to three basic rates, 12%, 25% and 33%) and cuts in the company tax rate to around 20%-25% (from 35% currently).
- Health care reform: Repealing Obamacare with a focus on reducing costs and entitlements.
- Defence: Increased spending on both Defence ($US450bn) and Veteran’s programs ($US500bn).
- Trade policy: A much more aggressive trade policy, including naming China as a currency manipulator and imposing tariffs on selected Chinese imports, changing the terms and conditions and NAFTA and abandoning the TPP. We note, however, that there is considerable uncertainty of whether Trump as President could act unilaterally on trade policy, or whether he would need the support of Congress (which may not be forthcoming) to change policy, especially treaties such as NAFTA.
- Immigration reforms: Reduce the flow of both legal and undocumented immigrants, including some deportation efforts and much tougher rhetoric.
- Infrastructure: An infrastructure spending program, similar to Hillary Clinton’s, of approximately $US300bn over coming years.
- Other: Housing finance reforms, loosening M&A regulations, loosening media ownership and liberalising energy drilling requirements, reversal of some climate change policies.
- It has been estimated that Trump’s policies would worsen the US budget position by around -$US3.5 trillion over the 2016-2026 period.
Trump’s policies would, over time, be highly stimulatory, expansionary and, ultimately, inflationary. Although there would likely be an immediate sell-off in risk assets upon a Trump victory on 8 November (ie. weaker equity and credit markets, a weaker USD and a rally in Treasury bonds), over the next year or so, if he was able to get his election policies through Congress, we are likely to see an acceleration in the pace of growth of the US economy and a surge higher in the USD. The equity markets are likely to respond positively to this stimulus. However, once these effects begin the fade, the downside risks are likely to mount.
The inflationary implications of Donald Trump’s policies are likely to see the Fed raise interest rates much more aggressively than currently priced into markets, taking bond yields sharply higher and short-circuiting the stronger economic data. Trump’s anti-trade policies and commitment to increasing tariffs are also likely to be negatives for growth, so that within a year or so of the policies being introduced the US economy, it could weaken significantly (perhaps heading towards recession), with the USD, bond yields and the equity markets all likely to decline as well.
The Grand Old Party (GOP)
More than one person I spoke with mentioned that the role of Paul Ryan as Speaker of the House would be a critical development to watch post-election – assuming a Clinton victory. As Speaker of the House, Paul Ryan is the most senior Republican in the current Congress. Depending on who you talk to, his less-than-fulsome support for Donald Trump is either a clever strategy to distance himself from an unpopular candidate, or a significant failure to back the candidate of his Party.
If Paul Ryan is replaced by somebody from the Conservative wing of the Republican Party (also known as the GOP – Grand Old Party), it could be a sign that supporters of Trump and/or the Tea Party have increased their influence and President Clinton will potentially face a very uncooperative House. If Paul Ryan retains his job, it is likely a signal that the more moderate elements of the GOP are in control and some negotiation on key areas of policy with President Clinton are possible. It is also a widely held view that helping to pass some meaningful reforms in the coming four years would be positive for Paul Ryan’s own Presidential ambitions.
Indeed, some people mentioned the risk of a GOP ‘civil war’ after the election – assuming Trump loses. Three key factions are expected to fight it out for dominance within the Party – the Trump supporters (angry that their candidate did not receive more support within the Party), the Tea Party (ultra-conservative both socially and economically) and the more moderate members of the Party. Which of these factions that comes to dominate could determine not only the strategy for dealing with President Clinton, but also the type of candidate the GOP puts up for the 2020 election.
Win or lose, it is my view that politicians, economists, the media and financial markets will need to do some soul-searching over why such a large number of Americans were drawn to Donald Trump. What will be important is not to ignore and unfairly characterise those in the US that feel like they have been left behind – either in an income sense or a status sense – but to support them through sometimes painful economic adjustments, so that they are not drawn to politicians that promise a return to the ‘good old days’ and a policy prescription that would end up doing much more harm than good.
It is important to recognise that some of the issues that have been highlighted in this election are very significant. Data from the US Census Bureau shows that around 40% of families in the US have seen very little or no increase in their real income since the 1980’s. Over the same time period, the top 20% of families have seen an increase in real income of around 30%, while the top 10% have seen an increase of just under 60%. In contrast, in the period from 1947 to 1973 the pace of increase in real family income in the US was roughly at the same rate for all income groups. It is little wonder, therefore, that those families in the lower income groups feel like they have been left behind and are looking for change and a focus on their needs.
As it was put to me by a very experienced political analyst I met with, Donald Trump has tapped into the concerns of a large group of people who have either lost their jobs, their relative income or (perhaps most importantly) their status. Unfortunately he has added a sense of racism, xenophobia and sexism that was very unnecessary. The real question for US politics is, therefore, what happens if a politician comes along (from either party) who can tap into the same economic, income and status concerns, but without the racism, xenophobia and sexism? Surely that politician would do very well?
As I was finishing this blog and preparing to fly out of Washington, news broke that the FBI was re-opening its investigation into Hillary Clinton’s use of a private email server and the possible mishandling of classified information. Reaction to this news was mixed, with Donald Trump championing the FBI and upgrading his attacks on Hillary Clinton’s honesty, while the Democrats continued to press the point that there was nothing new in any of the recent email revelations and that the FBI needed to quickly bring forward any new information. Whether this latest move by the FBI changes the course of the election is yet to be seen, but one of my taxi drivers in Washington – a man originally from Ghana and now living in the US – expressed great concern that this indeed would be the case.
One of my US colleagues put the election in context. His view was that a Clinton victory would produce a relatively narrow and normally distributed set of consequences and possible outcomes for policy, the economy and markets. In contrast, a Trump victory would produce a wide range of possible policy, economic and market outcomes, with significant tail-risk on both sides and the potential for a number of ‘black swan’ events.
So with less than a week to go to the 2016 US Presidential Election, markets will be holding their breath to see the outcome, as will most of the rest of the world. Given the importance of this election, I will be writing a note next week to update my views on the political, economic and financial market consequences of the result. In the meantime, I trust you have enjoyed the Blogs from my Japan and US Travelling Economist trip. The final Blog will be out later this week and will provide a summary and conclusions, as well as the financial market implications of what I have learnt along the way.
Stephen Halmarick Chief Economist