Back to square zero?

Of course, the impact of next week’s elections in the US goes well beyond the economic and financial realm, but from our narrow angle, we will follow the results across two dimensions. One is volatility: whether a winner emerges quickly with a margin wide enough to dispel the uncertainty which would come along a drawn-out contestation process. The other is directionality – whether Congress is politically aligned with the White House, so that we can have visibility on the policy stance in the world’s biggest economy.

A victory by Joe Biden is clearly the likeliest scenario at this stage, with a better than even chance for the Democrats to win the Senate as well. We think the equity market has reconciled with the “blue wave”, preferring to focus on a quick and powerful fiscal push in 2021 which will come handy given the deterioration in the macro outlook, rather than on the tax hikes. Meanwhile, the bond market is clearly pricing in a very significant rise in the funding needs of the federal government. In the medium-term, once the pandemic crisis is over, investors would probably become more sensitive to the capacity of a Biden administration to resist the pressure from the more radical elements of the Democrats if his party controls the three centres of power.

Donald Trump also can win this race, with a probability estimated at 10% by Nate Silver’s 538, nearly three times less than in 2016. But even in this case it would be highly unlikely for the Republicans to re-take the House of Representatives. This would be the status-quo outcome, which in the current circumstances would be equivalent to policy paralysis. Not necessarily a great configuration for markets in the current challenging macro environment. In any case, we may need days, and possibly weeks, for the dust to settle on this election.

Meanwhile, with large swathes of Europe returning to national lockdowns, a relapse in GDP contraction in Q4 in the Euro area is a done deal in our view. We explore ways to quantify this (with an activity impairment of roughly half of what was seen in the first wave, Q4 GDP could decline by 4 to 5% qoq). The second leg of the “W” would thus be much shallower than the first. Still, beyond the new shock, we think the entire trajectory for 2021 could be softer. Fortunately, this has been immediately recognized by the ECB which is explicitly readying what we think could be a very decent additional package for December.