Financial markets – a Rubik’s cube
In already volatile times, here’s what these potential outcomes mean for financial markets:
- This scenario is likely to be negative for the USD – its depreciation trend would likely continue, led by EUR, CAD and Emerging Market (EM) FX.
- The CAD and EUR may benefit from less contentious relations between the US, Canada and Europe – especially the EUR as the lingering threat of a trade war is removed. The JPY could benefit from lower US equities, lower real interest rates and more positive Asia-based risk conditions. Meanwhile, the RUB and (to a lesser degree) the GBP could lose out from a less friendly US political stance. While this scenario would be initially GBP-negative (and EUR-GBP positive, we think the outcome of the EU-UK trade deal will be a much more important GBP driver.
- A Biden victory could offer much-needed relief to global trade and would likely support a recovery in EM, especially AXJ and Mexico.
- The global rates outlook is less clear as Biden’s domestic agenda could weigh on US assets and drive US rates lower, given his ambitious spending plans and commitment to raising taxes.
- We would expect the commodity rally to continue on improved prospects for global trade and US infrastructure spending.
- We would expect a continuation of the ‘America First’ agenda, along with elevated risk premia as a result of Trump’s foreign policy and trade agenda. The USD is likely to rise initially on increased risk premia. However, after initial concerns about trade and geopolitical tensions are absorbed, we would expect the USD to resume its depreciation trend during a second Trump term.
- We would also expect Trump to take a more hostile trade stance towards the European Union (EU). The EUR and AXJ FX appear most vulnerable to Trump’s trade policies. However, the fundamentals of the US economy may weigh on the USD in the medium term.
- The status quo of Trump’s domestic agenda may initially support US assets, based on the assumption that tax rates will remain low and fiscal support will continue to favour demand-supportive measures.
- We would expect the status quo for US rates, but EM LCY rates may respond to any increase in curve-steepening risk or inflation risk.
- Crowded positions in commodities might initially be vulnerable to an increase in risk premia, but low real rates and inflation concerns should support gold and copper.
- A protracted election dispute is the biggest threat to markets for the rest of 2020, in our view. A long period of risk aversion would likely lead to a partial reversal of recent financial market trends.
- We would anticipate a temporary reversal of USD weakness, as the USD would likely rise on risk aversion and position reduction; but it may be vulnerable to protracted political uncertainty.
- US rates should decline on risk aversion, but EM LCY rates are likely to increase due to elevated risk premia.
- Gold might suffer initially as investors reduced exposure to crowded positions, but we believe that gold and safe havens such as the JPY would ultimately benefit from heightened election uncertainty.
Foreign policy - a binary outcome
The past four years have brought some significant shifts in US foreign policy. Regardless of who occupies the White House next, Washington is likely to continue to exert pressure on Beijing to open up China’s economy to US exports and investment, and to protect intellectual property rights and avoid the forced transfer of technology. We look at how foreign policy could be shaped in 2021 and beyond:
- This would likely see a reversal of the isolationist policies of the Trump administration.
- We would anticipate a return to multilateralism: re-joining the Paris Agreement on climate change, and probably the World Health Organization (WHO).
- A Biden administration is likely to strengthen relations with historical partners in Europe and Asia, and rebuild damaged ties with NATO allies to better address threats from Russia.
- Biden would reassess the US relationship with China, focusing on alleged "abusive" trade practices but also on human rights. Biden’s expressed strategy is to bring multilateral rather than bilateral pressure.
- The US would likely push to maintain its influence in Asia and continue ‘freedom of navigation’ exercises in the region’s waters.
- On counterterrorism, the focus would be on efforts through small groups of special forces instead of large troop deployments.
- In the Middle East, Biden has indicated that US policy towards some traditional allies could evolve. In particular, he said he would “order a reassessment of our relationship with Saudi Arabia” while warning the country to “change its approach”. He continues to support a two-state solution to the Israeli-Palestinian conflict.
- Biden has promised to hold Russia accountable for its actions, including US election interference.
- In Latam, Biden has said he would revive Obama’s overtures towards Cuba (reversed under Trump) and reassess the US strategy on Venezuela. Relations with Central America/Mexico might become less confrontational, while relations with Brazil’s Bolsonaro – an unconditional supporter of Trump – could worsen.
- Trump is likely to maintain an aggressive stance towards China and continue to focus on bilateral trade deficits.
- The counter-terrorism approach would likely focus on increased domestic surveillance, drone strikes abroad, and tighter limits on immigration and refugees.
- We would expect Trump to increase defence spending and support major new weapons programmes, while winding down US troop commitments in the Middle East and allied countries (i.e., Germany).
- US troop withdrawals from Afghanistan and Iraq would likely continue.
- The administration would likely keep the US out of international agreements that Trump claims infringe on US sovereignty.
- Cuts in foreign aid would likely continue.
- Trump would likely continue to provide strong support for Israel, Saudi Arabia, Egypt.
- On Russia, the US foreign policy stance might remain contradictory, with Trump willing to accommodate Putin and Congress seeking to punish him.
- In Latam, Trump would likely continue to pressure Central American states to cooperate on migration curbs; he might continue to blame Mexico for illegal immigration, unfair trade practices or even high rates of crime in the US; Bolsonaro’s Brazil would remain a strong ally.