The calm before the US election

Posted on September 1, 2016

Democratic presidential candidate Hillary Clinton speaks at a campaign event in Reno, Nevada on August 25, 2016. Clinton remarked that her opponent, Republican presidential candidate Donald Trump, runs a campaign based on prejudice and paranoia. / AFP PHOTO / JOSH EDELSONJOSH EDELSON/AFP/Getty Images©AFP

For the English reporter fetching up in the US, a habit of thought must be broken: treating what politicians say as policies that could actually happen.

The American system of separate powers for the president and Congress, which in turn has two houses elected in different ways, is designed to make change difficult at the best of times. Polarised and with neither party controlling all three, the result is gridlock.

    So, after six years of intransigence, the view of investors implied by markets appears to be that nothing much of consequence will change after November’s election. The stock market is calm, bond yields are low and stable, and attention is directed to whether the Federal Reserve’s next increase in interest rates will come this month or in December.

    Are they complacent? Opinion polls support the status quo assumption. Hillary Clinton has a clear lead both in the national polling average and the so-called swing states that tend to decide who becomes president.

    Yet while her Democratic party has a reasonable chance of retaking the 100-seat senate, according to the various analysts who pore over every survey of voting intentions, the House of Representatives is a different matter.

    As Republicans hold their largest majority since the 1928 election, they would have to lose 30 seats to cede control, but many are safe due to partisan drawing of boundaries and concentration of Democratic support in cities. The blue party has tended to win urban areas by larger margins rather than expanding the map of where it triumphs.

    Still, there is a material risk that either side could make a clean sweep. Iowa university runs a longstanding election betting market, which on Thursday put the chance of Democratic control of both houses at 23 per cent and the Republicans retaining both at 25 per cent. Take those at face value and there is almost a 50:50 chance of one party winning both houses.

    For a sweep to happen, the character of the presidential race would likely have to change again. Donald Trump could find a way to reassure and inspire his party to a famous victory. Alternatively, resignation and disgust, combined with his campaign’s scant advertising or state-by-state organisation to get out the vote, could see Republican turnout collapse.

    In either scenario, it suddenly becomes possible to contemplate changes to the US tax regime and new government spending. Both candidates have aspirations for large infrastructure programmes and tax cuts for their constituencies. Mrs Clinton would support a higher minimum wage.

    Investors would then have to contemplate the consequences for markets, with the boost to growth likely to lead to higher interest rates and bond yields, as well as a stronger dollar, similar perhaps to what followed Ronald Reagan’s 1980 landslide.

    Of course, there is the question of what complacency looks like. Ahead of the UK vote on membership of the EU in June, the polls were wrong but markets were far from gung ho.

    For instance, prices for option contracts that gave the right, but not the obligation, to buy or sell the pound at an agreed price after the vote got the magnitude of the collapse in sterling that followed about right. The lack of enormous profits or losses by hedge funds reflects how taking big bets on the outcome of the referendum was seen more as a way to get fired than to profit.

    US election poll tracker

    Which White House candidate is leading in the polls?

    There seems to be less concern about the implications of the US election, however. Bank of America Merrill Lynch highlights depressed currency volatility as evidence. Option contracts are priced according to assumptions about how violent market movements are likely to become, and the so-called implied volatility for the dollar-euro exchange rate in three months’ time is close to its lowest level this year.

    Meanwhile, one of the most popular option bets is for a stronger Australian dollar, which tends to serve as a proxy for emerging market currencies whose fortunes are tied to commodity prices. A rising US dollar would be bad for those positions.

    For now, policy will continue to be redundant in an election about character. What bears consideration is the settled consensus of the market, that the candidates’ policies will still be redundant once the result is known

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