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US Election Special: Fiscal Effects of Harris vs Trump

• Although both US presidential candidates Trump and Harris are likely to continue to run large deficits and grow US debt outstanding, the impact of their proposed policies may have different effects on the near-term fiscal trajectory of the United States. At some point soon in the future, the US will need to get its fiscal house in order, otherwise it runs the risk of debt spiralling higher (compounded by interest expense and growing entitlement costs) and/or an eventual run on the dollar.
• With the US Presidential election around the corner, we break down what both sets of plans may mean for government debt, deficits, and ultimately, US Treasury supply and interest rates (via term premium), as initially presented by the nonpartisan, non-profit group CRFB). We also explore the current US fiscal situation the winning candidate will inherit.

US Fixed Income: Restrictive Fed and 2yr selloffs

Macro View: Despite the rosy September report, the labor market has been weakening for a while now—one positive report does not dissuade us from our view that the jobs market isn’t as strong it looks. September’s NFP report showed an out-of-consensus 254K gain accompanied by a 72K upward revision to the previous two months. Job gains were broad-based, and the unemployment rate fell to a three-month low of 4.1%. However, four of the past six months have seen NFP prints under the breakeven minimum job growth (around 175K). Furthermore, there are risks that September data was overstated and will eventually be revised lower, especially given the low seasonal adjustments ratio. Overall, issues with data revisions and quality remain present.

As for inflation, though core CPI prices increased by 0.3% m/m for another month in September, we believe the higher-than-consensus number can be attributed to one off upside factors, rather than the start of a sustained increase in prices ahead. Notably, there was finally progress on housing inflation metrics (CPI rent and owner’s equivalent rent (OER) that finally softened more in line with market-based rent metrics. Recall OER has been the main driver of keeping inflation sticky and high.

Fed view: Against a backdrop of a generally softer jobs market and continued progress towards 2% inflation, we expect two 25 bps cuts at the Fed’s November and December meetings (regardless of US election outcome). That said, the bar to cut in December has risen. If for example there is a red sweep and that leads to a further rise in equities and then a surge in retail spending into the holiday shopping season (resulting in a last dash of hiring more retail workers too), of the two meetings left in 2024, they could skip December if we get such an optimistic scenario. If the Fed skips December they would likely lay the ground work for fading out QT as an easing compromise, in our view. Overall, after the Fed’s initial 50 bps cut, recent Fed speaker commentary as well as the minutes have been in line with slowing the pace of easing.

Election view: The momentum has shifted as Trump is now leading in most swing state polling, and has taken the lead in prediction odds markets. In addition, the “balance of power” expectations for all three branches of government (in prediction sites and how financial markets are trading–see bank stocks, cryptocurrencies, the US dollar and US rates), are suggesting that it will be a red sweep. In light of these developments, we shifted our election probabilities, as seen in Figure 1. Granted, a lot is already priced in for a red sweep, especially for 10-yr yields, that said we could see another quick 25-40bps short-lived selloff from 4.25%. The surprise factor will be if Harris can pull off an unexpected win. If Harris wins, we would expect a mirrored reaction, a 25-40bps rally. A Harris gridlock outcome limits the ability to implement all of her policies, and early in 2025 if the GOP does not win the White House, the debt ceiling could be acrimonious.

FX Outlook

The US dollar has strengthened notably since the last release of the Global Markets Monthly (24th September), by 3.2% as the market pivoted away from the prospect of more aggressive easing by the FOMC. The pricing in the federal funds futures market for rate cuts by the end of 2025 has plunged by 80bps since the end of September as the US jobs report at the start of October proved stronger than expected. The data is not the only factor for this shift with investors increasingly pricing for a Trump victory in the presidential election on 5th November. A Trump presidency is being associated with higher inflation due to Trump’s tariff policies and plans for large tax cuts. Given we see the economy proving weaker than expected and given our current forecasts are based on a Kamala Harris victory, we see scope for the Fed cutting more and for the US dollar to weaken again. With notable differences in policies between the two candidates we see a divergence implying the US dollar being 7%-8% stronger relative to our current forecast profile if Trump wins.

USD/JPY - Bearish Bias - 145.00-157.00

EUR/USD - Bearish Bias- 1.0400-1.1200

USD/CNY - Bullish Bias- 7.0000–7.2000

KEY RISK FACTORS IN THE MONTH AHEAD

• The obvious near-term risk for all currency pairs, including USD/JPY is a Trump victory that propels the US dollar a lot stronger. This risk however may be diminishing somewhat given the gains for the dollar and increase in US yields suggest a Trump victory is now much better priced. The general election outcome creates added uncertainty in Japan and while we do not expect this to be a sustained driver of yen selling, it could create volatility beyond our expectations.       
• The main upside risks for EUR/USD include: i) an election victory for Kamala Harris triggering an unwind of Trump trades built up in recent weeks. A Trump win with a divided Congress may also dampen further USD upside after the US election, and ii) the US labour market weakens more sharply than expected heading into year-end encouraging market expectations for the Fed to cut rates more quickly again.  
• The main upside risk for USD/CNY is the return of Trump to the White House and the implementation of his Tariffs plan. If Trump is elected and vows to impose an outsized 60% tariff on all imports from China, it would hurt China’s exports and put additional pressure on China’s economy when domestic demand is still sluggish. This could also incur broader risks to the global economy including the US economy, as such action could push up US inflation, pressure on US growth, and create negative spillovers to other economies. There are downside risks for USD/CNY too, which include larger size fiscal support, and an unwind of recent Trump trade if Harris wins the election