Image by DWilliams
The US elections brought Joe Biden to the White House, but without reflecting any mass conversion to his party’s policy agenda.
For now, the equity market is welcoming the outcome, expecting the usual “checks and balances” in the US institutional system to take the edge out of the most profit-damaging aspects of the Democrats’ economic agenda – namely reversing Trump’s deregulation push and tax cuts.
From this point of view, investors can take comfort in the fact that, in his victory speech, President-elect Biden insisted on cross-party cooperation and the need to unify the country.
"For now, the equity market is welcoming the outcome."
Looking ahead, the issue at stake is whether there is political space for a centrist approach addressing the underlying economic issues which have contributed to the rise in populism in the first place, or if Biden’s victory will act as a mere stop-gap, “lowering the temperature” for a while in the US political discourse but essentially masking policy paralysis.
Market focus is for now on the chances of a swift additional fiscal push, and indeed this is crucial for the short-term economic outlook, but more fundamentally, we think that the capacity to fight “secular stagnation”, which implies reviving productivity and innovation, should ultimately be the right gauge to the success of Joe Biden’s presidency in the economic realm.
The Democrats might still secure a majority in the Senate.
For now, the two parties control 48 seats each, with 4 races still to conclude. It would take a major upset in late counting for the Republican candidate to lose his edge in North Carolina. Results in Alaska take time (only 56 per cent of the votes have been processed so far) but the Republican incumbent is a clear favourite there.
So, taking on board Kamala Harris’ tie-breaking vote, it seems that the Democrats absolutely need to win the two run-offs in Georgia on January 5th.
"Most commentators are circumspect on the Democrats’
chances to win both seats."
The “Biden effect” is plain to see there as well. In one of the races, Democratic candidate Raphael Warnock together with the other democrats (Georgia conflates primaries with the final election) got 48.4% of the votes, and in the other Jon Osoff secured 47.9%, both below Biden’s score in this state he won by a razor thin margin (49.5% to 49.3% for Donald Trump).
Both parties will pour massive resources into the January race there and flipping 1 or 2% of the votes is of course possible.
Still, most commentators are circumspect on the Democrats’ chances to win both seats. They will have trouble generating the same level of mobilisation in these run-offs now that Donald Trump has lost, while Republican voters will have a strong incentive to go to the polls (avoiding a Democratic “trifecta”).
In our baseline Congress would remain divided, reducing the room for manoeuvre for Biden on delivering a large fiscal push quickly.
True, the US dataflow has been more than decent lately, which would suggest there is no emergency on this front. The manufacturing ISM index hit in October its highest level since the summer of 2018. The more significant non-manufacturing ISM edged down, but at 56.6 remained well into expansion territory.
"We still believe there is some underlying softness in the US
when looking at the labour market"
This comes in sharp contrast with the Euro area where the composite PMI index for October, at 50.0, stood right on the line between expansion and contraction.
Yet, we still believe there is some underlying softness in the US when looking at the labour market, even without factoring in the ongoing deterioration on the Covid front.
The “employment” component of the non-manufacturing ISM is now barely in expansion territory (see Exhibit 1). The market took comfort last week in a better-than-expected payroll report, but the improvement remains very small when measured against the massive loss of the first wave (see Exhibit 2).
Exhibit one.
There is still some “acquired speed” in the US recovery, but it could do with another push.
Upon being re-elected in Kentucky, Republican Senate majority leader Mitch McConnell sounded quite open to finding a deal with the Democrats on a quick stimulus package – calling this the number one item on the Senate’s to-do list when reconvening for a “lame duck session” – but this came with strong qualifiers.
He seized on the positive surprise from the payroll batch to state that “it reinforces the argument that I’ve been making for the last few months, that something smaller – rather than throwing another USD 3trn at this issue is more appropriate”.
Exhibit two
Earlier in the year the Senate had proposed a USD 500bn package, while the House is now targeting USD 2.2trn, down from an original plan at USD 3trn. Nancy Pelosi the same day last week stated that a narrow bill “doesn’t appeal to me at all”.
There may well be a deal – which may be tagged to the resolution which Congress needs to pass anyway by December 11th to avoid another shutdown – but it’s unlikely it will be as large as what the Democrats want.
Then we also must factor in potential disruption from the White House.
Donald Trump is President until January 19th. Negotiations on an immediate relief bill would have to involve the Treasury department and the White House.
Secretary Mnuchin and Nancy Pelosi were apparently close to a compromise before the elections, but it is unclear how cooperative the executive branch of government is going to be during the transition phase, while the Democrats may be reluctant to sit with the Senate Republicans if most of them align with the incumbent President in refusing to accept the legitimacy of the election results.
This is one of the channels through which a persistent refusal by Donald Trump to concede could create some market movements ahead.
"A persistent refusal by Donald Trump to concede could
create some market movements ahead."
US 10-year yields have corrected from their pre-election high at 0.92% on November 3rd, when the “blue wave” was the market’s central scenario (ours as well for that matter), but equally rebounded from their relapse at 0.72% on November 5th to settle slightly above 0.80% on the 6th.
This probably reflects some “wait-and-see” attitude while the dust settles (which may take until the Jan 5th elections in Georgia). The equity market halted its rally on Friday, probably taking time to ascertain whether a fiscal push could prolong it by supporting cyclicals.
While investors are understandably focusing on these immediate consequences of the elections, we think there should be some bandwidth left to discussing the US long-term growth strategy, and whether the new political configuration makes it easier to emerge.
The received wisdom is that before Covid hit, Donald Trump would have been re-elected easily given the strong performance of the US economy.
GDP growth was decent, that much is true, but this was made possible by an already accommodative fiscal stance.
In the three years to the end of 2019, US GDP grew by 2.4% per annum on average, in the same ballpark as during the last three years of the Obama administration (2.5%).
Still, in the meantime, the US federal deficit literally exploded from USD587bn to USD 998bn in 2019, essentially because of the sweeping tax cuts enacted at the beginning of Trump’s mandate.
This is growth “on steroids”, which does not reflect the real state of the economy. The US remains in a better position than Europe in terms of growth performance, but its underlying path, after controlling for short-term policy props, has significantly slowed down.
The most cogent analysis we have encountered so far on this is Larry Summers’ secular stagnation.
In his narrative, at the root of the economic morass is a slowdown in technological innovation which is impairing productivity growth. Summers’ recommendation is to lift public investment – in particular infrastructures – in the hope it can kickstart a rebound in productivity.
It may sound distant now, but Donald Trump’s own electoral platform in 2016 was steeped into the “secular stagnation” approach, as a massive infrastructure spending plan – which did not come to fruition, largely because of the opposition of Republicans in Congress - was one of his key proposals then.
The decelerating trend in public investment, which started in the early 2000s and intensified during the Great Recession of 2008/2009 (partly under a Democratic administration) has not been reversed (see Exhibit 3).
The “Summers approach” was adopted by Biden with a twist: the green transition, to be heavily funded by the government, is intended to be one of the key vectors of innovation.
If the Democrats fail to snatch a majority in the Senate with the run-offs in Georgia, it is unclear how Joe Biden’s own USD1.5trn infrastructure plan skewed towards renewable energy could come about.
True, the President-elect’s bi-partisan credentials can help him to secure deals with some moderate Republicans in the Senate. They are an endangered species, but a few are remaining (e.g. Mitt Romney, Lisa Murkowski, Susan Collins). Still, they tend to be run-of-the-mill fiscal conservatives.
Yet, macro strategies don’t have to be one-sided. Summers focused on the deterioration of US infrastructures, which unsurprisingly appeals to the “big government” left, but one could equally attribute some of the slowdown in productivity in the US to an “ossification” of the US economy due to a lack of competition.
Thomas Philippon (in his book “the Great Reversal”, published in 2019) has been instrumental in pushing this thesis, highlighting the fact that in some key sectors – telecommunications for instance – the level of competition is now higher in Europe than in the US.
"In some key sectors the level of competition is now higher
in Europe than in the US."
Some of the countries which successfully reformed in the 1990s and 2000s pursued dual strategies. Canada for instance responded to its deep crisis in the early 1990s by liberalising its economy while raising its public investment effort once they had restored their public finances.
In principle, there would be space for a cross-party macro strategy in the US, a “purple pathway”, with the Democrats’ fondness for public investment complemented, or partly offset, by tougher competition policies which would appeal to free markets Republicans.
Moreover, although the Republican party under Trump has been dominated by its climate-sceptic wing (note that Mitch McConnell’s state is the fifth biggest coal producer in the US), some of its Senators – including Lindsey Graham, otherwise a staunch support of Donald Trump - acknowledged that global warming is man-made and agree with the need to cap carbon emission.
However, they would rather achieve this through market mechanisms, with government “nudge”, while the Democrats are on the whole more supportive of direct intervention.
The room for manoeuvre for Biden will be narrow though.
Even moderate Republican Senators may have to compose with a still Trumpian base, allergic to any cooperation with the other side.
Utah Senator Mitt Romney – who supports a market-based greening of the economy – stated this weekend that Donald Trump will “be the 900 pounds gorilla when it comes to the Republican party” and will continue to influence its stance.
"The Democrats themselves may have some trouble
keeping their own radicals in check."
Romney may have summarised the view of the Republican establishment quite well by saying that “[Americans] don’t want the Green New Deal, Medicare for all, don’t want higher taxes, don’t want to get rid of oil and gas and coal”.
This sets clear limits to the extent of cooperation. At least at this stage. The Democrats themselves may have some trouble keeping their own radicals in check.
There is probably no Democrat better equipped than Joe Biden to deal with a divided Congress. Still, if the centrist avenue is blocked, the result may well be policy paralysis.
