As former Vice President Joseph R. Biden becomes President-elect, Republicans will likely hold onto the Senate. Democrats have a potential path to Senate control, but the market is assigning a low probability they capture both seats in the Georgia runoff in early 2021.
Markets have historically preferred multi-party oversight to prevent overreach and assure legislative compromises, and are generally embracing this outcome. Indeed, in the current environment this power mix will limit the potential for major disruption to taxes or regulations.
While volatility spiked leading up to the election, it has been receding as the results settle in. Equities, the dollar, interest rates and corporate spreads have all seen volatility abate as investor sentiment remains strong.
International trade and global markets
Biden’s respect for institutions and a rules based backdrop will likely nurture alliances and reduce the risk of trade disruption. While Biden will continue to be tough on China, it is unlikely he will adjust tariffs. Renewing support for the Paris Agreement, the World Trade Organization (WTO) and the World Health Organization (WHO) seem like priorities, as Biden sees U.S. leadership as critical to global coordination.
Containing the pandemic is essential to market confidence, and the recent news of two successful vaccine trials has ignited equities. The Treasury curve steepened as the spread between 2 and 10-year Treasuries hit its highest level in over 3 years, in anticipation of stronger growth.
The U.S. dollar could start to weaken, as a more predictable U.S. eliminates some of the geopolitical risk hanging over markets. Historically, the dollar behaves as a counter cyclical currency. When markets are fearful the dollar strengthens. However, when non-U.S. growth prospects improve the dollar starts to lose ground.
A Biden presidency with a divided congress is a version of the current dynamic. There will be no Democratic-driven grand stimulus as Republicans will likely revert back to being fiscal hawks.
Lack of any sizeable fiscal program will leave the Fed as the main steward keeping the economic recovery on track. That reduces the risk of an inflation surge and will continue to pin rates close to zero. Low rates with reasonable growth prospects have been a constructive environment for equities and that support will likely continue.
The U.S. recovery is showing momentum, but will take until well into next year to match pre-pandemic levels, as unemployment is still near 7%. Demand for housing is surging, and while auto sales have been strong they have started to cool. Consumers have generally being keeping up with their bills, but data from the Federal Reserve Bank of New York shows credit card and auto delinquencies over 90 days are ticking up.
Household savings have jumped as consumers banked their stimulus cheques and unemployment benefits. This gives them some runway to tolerate income interruptions. But given the measured pace of employment gains, consumer stress could elevate unless there is some follow on stimulus post inauguration.
The promises and policy ambitions that new President’s bring can favour or handicap various sectors of the economy. At the core of Biden’s agenda is funding green technology, expanding healthcare, increasing taxes and regulatory oversight of technology. But without senate control he is unlikely to succeed with anything transformational.
Banks are one sector that could see regulatory tightening under Democratic control. Revival of the Glass-Steagall Act, expanded consumer protection or a financial transaction tax would all be possibilities in that scenario. The current administration has allowed some financial sector deregulation, but the core of what was enacted in response to the 2008-09 financial crisis still remains intact at the largest banks.
On the campaign trail Biden favoured building on the Affordable Care Act (ACA) through offering a public alternative alongside existing private health plans. He also wants to expand Medicare through lowering the eligibility age. However, any material enhancements to the ACA are unlikely to garner much bi-partisan support. One area that could attract support is some oversight of drug pricing. Pharmaceuticals have been accused of price gouging in the past, so clamping down on predatory activity could be popular.
Biden’s climate change agenda will likely show up in his approach to energy. While the former Vice President sought to assure voters that he would not outlaw fracking, he may immediately ban new permits to drill on federal land. Over the long-term, any shift to more environmentally friendly energy will constrain traditional energy expansion which could drive consolidation.
Technology companies have been under siege from both sides of the aisle on protecting consumer information. Progressive Democrats would prefer more consumer driven control over how their information is used while a Republican Senate is more hands-off. Expect some government guidelines or a rush by big technology companies to self-regulation. Privacy issues are becoming critical as technology logs a significant number of personal transactions creating vulnerabilities for misuse of sensitive information.
Corporate America has been well-supported by an accommodative Fed. With low rates and ready access to borrowing, most large companies fortified their balance sheets creating a capital reserve to tolerate any extended weakness. And with higher corporate taxes unlikely, profitability should be sustained. The latest round of U.S. corporate earnings have handily beaten expectations as companies find ways to restore activity.
After record corporate bond issuance this year the outlook for corporate bonds remains strong. Defaults are expected to mitigate and the pace of downgrades, from the rating agencies, has slowed. Spreads remain tight and a reasonable pace of recovery should keep them in a narrow range.
Risk to the outlook
As the pandemic intensifies over the winter months, the drop in unemployment benefits could strain savings, and in turn ignite a wave of delinquencies across mortgages, credit cards and autos. Both parties seem interested in getting a relief deal in place but have haggled over the size of the package. The hope is that something happens early in the first quarter to help keep hard hit households current on their bills. Unemployed Americans are clearly concerned about maintaining a savings buffer and presumably Congress will remain attentive to their plight.
To gauge the strength of the U.S. economic recovery, monitoring consumer health is critical. Broadly, consumer health is holding up. For instance, third quarter rent tracking from the National Multifamily Housing Council show payment levels close to where they last year. Strong rent collections were also confirmed by the six largest U.S. REITs.
Two sectors that are close to the health of the consumer are Asset Backed Securities (ABS) linked to credit card and auto payments. Right now, spreads on the higher quality tranches for each have been stable, indicating a positive outlook on defaults. The ability to meet payments for some loans in these structures will depend on further stimulus and a measured recovery.
Paying attention to the interplay of government support and consumer health is as important as the other key relationship, the Fed’s commitment to assure well-behaved credit markets.
In 2020, our deep-dive credit analysis across public and private asset classes helped us outperform for our clients in a volatile macroeconomic environment. We now end the year with the country beginning to move past a contentious election season and the promise of a successful vaccine. While the new year will likely bring new challenges, we are confident that our investment teams and credit research approach will continue to help our clients successfully navigate the financial markets in 2021.
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