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Monday, November 04, 2024

BATTLE AT THE BALLOT: Election Impact on Inflation, Rates & Stocks

By Century Financial in 'Investment Insights'

BATTLE AT THE BALLOT: Election Impact on...
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The inflation story, which had gripped the global capital markets since 2022, started ebbing away gradually over the second half of 2024. Inflation readings exhibited a declining trend with only a few minor bumps along the road. As a result, the Fed’s focus started shifting from combating inflation to preserving economic strength. However, with the U.S. presidential election looming just around the corner, followed closely by the FOMC meeting – everyone is revisiting the inflation story. The markets are abuzz with fresh chatter about the potential implications on inflationary pressures and interest rates under Donald Trump and Kamala Harris. Both candidates are neck and neck in a tight race and offer starkly divergent views on economic issues, foreign policy, and international relations. After a gruelling two-and-a-half-year battle with inflation, the Fed can finally see the finish line in sight – with inflation nearing the 2% target and no sign of a recession. Whether it will succeed or not hinges heavily on the election outcome.

Donald Trump

Potential impact on inflation and interest rates

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Wall Street is largely of the opinion that Donald Trump’s proposed policies could potentially stoke inflationary pressures. Trump has been very vocal about his desire to levy crippling tariffs on imported goods in a bid to spur domestic manufacturing. This could trigger an all-out disruptive trade war with countries like China and potentially redefine international trade relationships if other countries retaliate. Given the strained relationship with China, Trump has proposed a 60% tariff on Chinese imports as against 10% to 20% for the rest of the world. If this happens, the average tariff, weighted by the value of imports, could skyrocket to 17% from as low as 2.3% in 2023 and 1.5% in 2016. Historical analysis reveals this would mark the highest tariff since the Great Depression – when Congress passed the Smoot-Hawley Tariff Act. At the time, this had sparked a substantial uptick in trade barriers across the globe.

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Tariffs could also impact industries other than manufacturing. The U.S. imports 70% of its seafood and over 99% of its coffee. Nearly 60% of fresh fruit and 38% of vegetables consumed by Americans are imported from other countries. Heavy tariffs could heighten the cost of imports, thereby hurting American consumers. Latest reports indicate that governments and companies around the globe have already started developing contingency plans to safeguard against potential Trump tariffs. Any resultant supply shocks could potentially revive inflationary pressures. Trump advocates argue that Trump tariffs only impacted about $300 billion in imports in 2018-2019, most of which were from China. However, Trump is currently proposing tariffs on over $3 trillion worth of imports from across all countries.

Trump is also contemplating radical changes to immigration policy with mass deportation on the cards. This could lower the supply of workers, thereby tightening the labor market. With fewer workers available, businesses would be compelled to either raise wages or hike prices – which could contribute to inflation. If the Republicans win full control of Congress, then Trump would have even more freedom to change existing trade and immigration policies. The former president has also proposed lowering the corporate tax rate from 21% to 15% - a move that could substantially dent government revenue and increase the government deficit. Economists expect this to add about $8 trillion to the national debt over the next 10 years. If that happens, the U.S. government will have to resort to bond issuances to raise capital. This could prop up treasury yields and keep interest rates elevated. The energy sector, on the other hand, could experience lower inflation as Trump vows to slash regulations to encourage more production.

Although the election outcome is highly uncertain, both mortgage and bond markets have started pricing in the prospect of Trump securing a seat at the White House table. The average 30-year mortgage rate surged by 45 basis points to 7.09% in September 2024 as Trump’s odds against Harris improved. Similarly, the 10-year treasury yield also surged by 49 basis points to 4.24% as forward-looking inflation expectations rose. Broadly speaking, markets expect an environment of higher interest rates if Trump wins the election. Trump is also demanding a say in the Federal Reserve’s monetary policy decisions – which is not viewed favorably.

A Trump presidency is likely to intensify uncertainty as his policies will have far-reaching and slightly unpredictable consequences on foreign policy, international trade, immigration, and the U.S. economy. In such situations, investors tend to flock to safe-haven assets like the U.S. Dollar and gold. If his policies trigger a revival in inflationary pressures, then the U.S. Dollar could strengthen as interest rates could remain high. While a stronger greenback tends to dent gold’s appeal, in this case, we can expect gold to remain resilient and serve as good hedge in investors’ portfolios – particularly given the other fundamental factors supporting the precious metal.

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Kamala Harris

Potential impact on inflation and interest rates

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The 2017 Tax Cuts & Jobs Act, which turned out to be one of Trump's signature moves while he was in offce, is scheduled to end in 2025. This act greatly reduced the corporate tax rate to a flat 21% from 35%. When it comes to this particular act, the Democrats hold a different point of view, pointing out the uneven benefits this act provides the wealthy. Now, Kamala Harris’s administration is proposing new tax measures. Harris is looking at increasing the capital gains tax rate from 20% to 28% for those earnings over $1 million annually. More importantly, the proposal is set to raise the corporate tax rate to 28% from 21%. This increase is expected to see a rise in U.S. governmental revenue and shrink the deficit gap, which in turn could reduce dependence on public markets for governmental borrowing, leading to potentially lower yields or interest rates under Harris’ presidency.

Beyond tax reform, there is the matter of inflation. Inflation has been on a declining trend for the most of 2024, although certain staples like groceries, food and healthcare have remained persistently high in pricing. The Harris administration is keen to address these high costs for the resident in America. To tackle this, Harris is proposing a first-ever national price-gouging ban on food and groceries, aimed to curb corporations from inflating prices unfairly at the consumers’ expense. Moreover, Harris’ policies also include the proposed one-time offer of $25,000 in assistance for first-time homebuyers, in efforts to reduce healthcare and drug prescription costs. Finally, Harris’ plans & policies are estimated to raise U.S. debt by about $4 trillion over the coming decade. This figure, albeit significant, is about half compared to Trump’s estimated addition to debt of $7.8 trillion. Lower governmental expenditure combined with efforts to curb essential costs could help sustain low inflation levels. Lower interest rates and low inflation could likely pave the way for a weaker dollar under Harris administration.

Stock Market Playbook: Trump vs. Harris

In just a week, voters in the US would be all set to elect their next president. Though initially the election was considered a rematch between Trump and Biden, in late July, Biden withdrew from the presidential race, announcing Harris as the presidential candidate.

Now, the big question is whether America will get its first female president or a second Donald Trump term.

Though historically, markets can be seen to be pricing the outcomes of an event, the presidential elections have always been a hard guess. And the same has left many investors wondering how they can position their portfolios depending on the next possible president.

According to RealClear Polling, Trump is leading Harris in key battlegrounds by a narrow margin.

RealClearPolling

Source: RealClear Polling
Date: 28th October 2024

Below is a summary of the implications of different presidencies.


implications
Risks and Assumptions related to Back-tested trading strategies
The risks and assumptions listed here are not intended to be an exhaustive summary of all the risks and assumptions involved.
The strategy might suffer from look-ahead bias which occurs due to the use of information or data in a study or simulation that would not have been known or available during the period being analyzed. This can lead to inaccurate results in the study or simulation.
Future price movements may not be exactly the same as the historical price movements and this could lead to variation in performance.
Testing can sometimes lead to over-optimization. This is a condition where performance results are tuned so high to the past they are no longer as accurate in the future.
The model assumes no slippages in trading. Slippage refers to the difference between the expected price of a trade and the price at which the trade is actually executed.
The back-tested strategy might be at risk of data dredging, which is the behavior of testing multiple hypotheses at one time, resulting in picking the data that best supports your main hypothesis.
Drawdowns in actual trading can be higher than the tested system and losses could be significant in the event of leverage.
Unforeseen events can lead to variation in performance from the tested trading strategy.
The tested result has been computed with price feeds available from Bloomberg.
The testing environment has not considered transaction or any other costs.
Trading indicators used for the purpose of testing has been provided by Bloomberg.
The strategy might suffer from data mining fallacy, selection bias and backfill bias.
A trading strategy that performs well on multiple datasets from one market (e.g., forex) might not perform as well in another market (e.g., stocks).
The strategy may not depict accuracy in terms of spread changes due to the spread-widening events.

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