We are now less than a week away from the US presidential election, with the latest polls suggesting the race to become the 45th President of the United States is neck and neck. Bond and currency managers around the world are currently trying to assess how a win for either candidate might affect their portfolios. Here is my best estimate as to what might happen.
A Clinton win
A Clinton victory is seen by the markets as a continuation of the current US political environment, particularly if the Republicans retain control of the House of Representatives. This would be the most benign scenario for bond and currency markets as measured by price volatility. Following a Clinton win, the bond market would likely price in a higher probability of a move in interest rates, with the removal of perceived political uncertainty paving the way for a Fed rate hike in December. The US dollar stands to be the main beneficiary of this change in market pricing in the immediate future, though any gains are likely to be measured.
In a Clinton win scenario, bond prices across the Treasury curve would likely remain under pressure in the coming weeks given the high chance of a rate hike, rising inflationary pressures, and the possibility of an easier fiscal policy stance by a Clinton administration. A Clinton win is not likely to radically alter bond investors’ or economists’ views on the outlook for the US economy. If Clinton is able to implement easier fiscal policy in the US in the medium term, US growth and inflation would likely increase, meaning a rise in term premiums and a steeper yield curve.
A Trump win
A Trump victory would result in heightened volatility across a number of markets given the uncertainty around what the implications are for the US economy. Following the result, risk aversion would likely increase meaning a rising US dollar, lower bond yields and a weaker US high yield corporate bond market. In the fixed income universe, emerging market bonds and currencies would likely be hit the worst in this environment given Trump’s tough stance on China and Mexico. This market reaction could look similar to previous US risk-off events such as the 2008 financial crisis, the 2011 loss of the US government AAA rating, and the 2013 taper tantrum. The market reaction to a Trump victory might put the Fed off from hiking interest rates in December. Alternatively, should the Fed push ahead with a rate hike in an uncertain political and market environment, we may see an adverse reaction in markets similar to the 2015 rate hike.
Turning to credit markets, Trump’s proposal of a repatriation tax holiday would likely be positive for US investment grade corporate bonds at the margin and may lead to a reduction in corporate bond issuance. It is estimated that companies hold almost $1trn offshore, with around 60% denominated in US dollars. The big question is how companies would use this cash: will they pay out special dividends to shareholders? Will they increase capital expenditure and expand their operations? High yield companies would be less affected, as most companies have domestic sources of revenue.
Over the medium term, Trump’s proposals on large tax cuts for all is the equivalent of a large Keynesian injection of cash into the economy which would benefit economic growth but also raise inflation. The implementation of trade barriers would also be inflationary, as import prices rise from current levels. Immigration reform means the already tight US labour market would tighten further, leading to higher wages. Fed policy would need to counteract the rise in inflation, meaning much higher interest rates and a bear market for bond markets. The US treasury market would return to a world of higher yields and a much steeper yield curve. In this environment, the US dollar would likely strengthen given the contrasting monetary policy stance with other developed market economies. A Trump win would be good for government bonds in the short term, bad for bonds in the long term.
The bottom line
A Clinton victory would likely result in lower volatility in the near term relative to a Trump victory. In the immediate aftermath of a Clinton win, there may be some slight risk-on moves from investors but over the medium term much will depend upon the make-up of the United States Congress. Credit markets should prove to be relatively resilient, given that default rates are expected to remain low and the Fed remains cautious in removing policy accommodation, thereby reducing the chances of a policy error. A Trump victory would be seen as a risk-off event in the short-term, resulting in lower treasury yields, a higher US dollar and weaker risk sentiment towards emerging market assets. Given both candidates are advocates of an easier fiscal policy stance, government bond prices are likely to come under pressure in 2017 under both scenarios. Over the longer term, like a Clinton win scenario, the policies that Trump is able to implement given the make-up of Congress will be key to determining the outlook for the economy and consequently bond and currency markets.