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Playing the Trump trade right…

Despite a rapid rise in Republican/Red sweep betting odds ahead of the upcoming US election, we think there is more steam to the volatility and Trump trade. With the election still being a binary event, it is important to understand what this could portend for economic policy ahead - and potential impact on asset classes. While a Trump presidency will be more noisy and volatile, we assess that a Harris presidency will not differ too widely in certain key areas. Medium term - watch out for structurally higher volatility in global inflation and growth ahead, implying the conventional playbook of ‘buy the dip’ or ‘time rallies’, during the sustained equity bull markets of the ‘Great Moderation’, need a re-watch. Rising term premium will likely be the next driver of higher yields, whereas FX wars would be the biggest asset class risk that could unfold over the coming years. For India, FX and rates will be the first casualty with equities only temporarily rejoicing the Red sweep. There will be natural weakening bias for INR, led by CNY, while mild bear flattening may make a comeback.

Trump trade sweeping the markets?

US betting markets have meaningfully repriced in former President Trump’s favor in recent weeks, alongside some notable shifts in swing state polling. Corroborating trending US Presidential poll momentum, Senate polls have also narrowed in favor of Republicans, implying higher odds of a Republican sweep (vs split Congress). Consequently, global investors are starting to position and/or hedge election risk with ‘Trump trade’ leading to: i) higher UST yields (and DM/EM yields) and, in particular, a higher-medium term Fed terminal rate, ii) stronger dollar as an offset to tariffs, iii) outperformance of US vs non-US (DM) equities, iv) tighter US credit spreads as tax cuts make it even easier for corporates to service their debt, etc. That said, elections are still a binary event and we do not rule out more volatility for asset classes ahead. Thus, it is pertinent to understand potential US policy shifts in key economic areas, including fiscal, trade, immigration, and regulatory policy - to assess the near- and medium-term macro and global market implications post-elections

Trump vs Harris - Two peas of the same pod?

We focus on the two key areas where differences in approach of Trump and Harris - and the economic implications - could be the sharpest: trade and fiscal policy.

(i) Fiscal: Fiscal restraint may not be exercised by either; however, fiscal thrust from the Republican would come predominantly in the form of tax cuts, whereas Democrats would lead with more spending. Trump argues for full extension of the 2017 tax cuts expiring in end-2025, with spending focus on infra, tech, and defense. Meanwhile, Democrats oppose extending these lower marginal rates (implying corporate taxes back to 28%) and increasing the tax burden on the wealthy to fund the extension of health insurance subsidies and child tax credits. Broad extension of tax cuts was estimated to increase the cumulative deficit by USD4.6trn over a decade, with Trump-led policies being more extravagant at over USD7.5trn, sans any taxes/tariff hikes. A full Trump sweep would likely be the most equity-positive outcome with a favorable corporate tax regime alongside low regulatory burden, while any gridlock is technically equity market-negative. However, the gridlock would be the most bearish outcome for spending, implying good news for bonds. Expect bearish steepening on full sweep, with higher pressure on term premium in a Red sweep. However, ‘fiscal cliff’ chances on debt ceiling or government funding also increase with Harris-led split Congress. 

(ii) Trade: Trade would likely take a front seat in a Trump regime even as both regimes would remain firm on China levies, and protect sensitive industries such as solar and semis. Trump has floated a variety of proposals, from 60% tariff on all Chinese imports, 100% tariffs on EV imports from Mexico, to a universal 10% tariff on all imports. That said, broad tariffs imply downside risks to US/global growth, higher cost, and push firms to account for greater risk of frictions for supply chains and end-market access among other factors. We think the US election premium is not yet fully baked into the USD, and the bulk of the rebound owes to a re-pricing higher of UST yields. While Trump has vocally supported a weaker USD, we think his policies would lead to stronger USD in the near-term (also helped by higher fiscal-led US growth vs DM peers) amid USD’s anticyclical character. Democrat victory should see temporary USD weakening. But regardless of the election outcome, we expect heightened FX volatility and disrupted supply chains. We will watch for CNY-led Asian EM FX weakness, and INR following suit, even as it may stay in middle of the EMFX pack. We fear FX wars would be the biggest asset class risk that could unfold over the coming years, as China strives to survive its new export model of high-end manufacturing, amid growing Western resistance.

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