What Matters Most to Markets in the U.S. Election

While it’s too early to tell who will win the U.S. presidential election ­­­– or how markets will respond to it – there are a few factors that investors should consider.

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Welcome to Thoughts on the Market. I'm Michael Zezas, Global Head of Fixed Income and Thematic Research for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the impact of the US election on markets. It's Wednesday, January 24th at 10 a.m. in New York.

We're two states into the Republican primary election season. Former President Trump has won both contests, underscoring what polls have been suggesting for months now. That he's the heavy favorite to be the party's nominee for the presidency. But other than that, have we learned anything that might matter to markets? Not particularly in our view. This election will clearly be consequential, the markets, but for the moment we're more in watch and learn mode. Here's two reasons to consider.

First, knowing who the Republican candidate will be doesn't tell us much about who will become president. While we've heard from some clients that they rate President Biden's chances of reelection as low, and therefore, knowing who will be the Republican nominee is the same as knowing who will be president, we don't agree with this logic. Sitting presidents have had low approval ratings this far ahead of an election and still won before. Also, polls may show that economic factors like inflation are a political weakness for Biden today, but those circumstances could change given how quickly inflation is easing. Now, this doesn't mean we expect Biden will win, it's just that we think it's far from clear who the favorite is in this election.

Our second point is that, even if we know who wins, we don't necessarily know what reliable market impact this would have. That's because there are many crosscurrents to the policies each party is pursuing. Democrats may be interested in more social spending, which could boost consumption, but they may also be interested in taxes to fund it, which could cut against growth. Republicans may be interested in lower taxes, but the presumptive nominee is also interested in increased tariffs, which could mitigate tax impacts. To top it off, neither party may be able to do much with the presidency unless they also control Congress, something that polls show will be difficult to achieve.

So, this all begs the question. What will make this election matter to markets? The answer, in our view, is time and market context. As we get closer to the election, what's in the price of equity in bond markets will largely shape the stakes for investors. For example, if markets are priced for weak economic outcomes, investors may embrace a unified government outcome regardless of party, as it opens the door to fiscal stimulus measures. Of course, this is only one scenario that may matter, but you can see the point on how context is important. So as the stakes become clearer, we'll define them here and let you know more about it.

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