Will Tuesday deliver another surprise

Principal Economist's View

Download the PDF version including our economic update by region here: Will Tuesday deliver another surprise?

View our Economic and Research team's perspective on the economic implications of Trump vs Biden in slide form.

The first Tuesday in November is always a momentous occasion. For most Australians, it denotes the Melbourne Cup. But for Australian economists, it marks one of the eleven RBA meetings each year. Historically it has been a meeting where the RBA has delivered more than any other month, along with May. This year should be no exception and we expect the RBA to cut the cash rate from 0.25% to 0.1%, lower the 3-year government bond yield target from 0.25% to 0.1%, cut the interest rate on exchange settlement balances and potentially flag a long-term bond buying program (i.e., quantitative easing).

However, for the rest of the world, the day gains special significance as every four years it typically marks the US Presidential Election. While pundits are nervous in making any predictions given 2016's surprise result, Biden is clearly leading in the polls (51% vs 44%), betting markets (63% vs 36%) and various election models (~88% chance according to FiveThirtyEight).

How could the election outcome impact the US macroeconomic outlook? Clearly, there are substantially different policy agendas between President Trump and former Vice President Biden. Biden has proposed significant increases in spending on health, education, child/elder care and infrastructure, particularly towards clean energy given his target of net zero emissions by 2050. We assess Biden's policies as boosting government spending by $7.3 trillion over ten years. This is partly funded by higher taxes, particularly increases in the corporate tax rate (21% to 28%) and income tax on those earning more than 400K per year, which would raise $3.4 trillion over the next decade. Democrats are also proposing significant near-term fiscal support, with their original $3.4 trillion HEROES Act proposal documenting their spending wish-list. All up, if Democrats got their way, a total of $7.4 trillion of stimulus could be injected into the US economy over the next decade.

Of course, whether this is achievable depends on the outcome of the Congressional elections. The House will remain with the Democrats, but the Senate is still in play. Here, betting markets are giving Democrats just below a 60% chance of gaining control from the Republicans, while election models are closer to 77% (according to FiveThirtyEight). Nonetheless, it is virtually impossible for the Democrats to claim 60% of the Senate seats. This is important as even if Democrats claim a majority in the Senate, Republicans will still be able to use filibusters to block proposed legislation. Given this reality, even if we witness a Blue Wave next week, our assessment is that Democrats will only be able to implement around $3.9 trillion of stimulus over the next decade as Republican Senators will block many of Biden's spending proposals.

Our modelling of this Blue Wave scenario boosts real GDP growth by 2.3ppt in 2021 and a further 0.4ppt in 2022 relative to the status quo scenario due to $1.0-$1.5 trillion more near-term fiscal stimulus by a Democrat-controlled Congress. Inflation will recover more swiftly, with the stimulus boosting PCE inflation rates by 40bps in 2021 and 50bps in 2022 to 1.9% and 2.2% respectively. This will allow the US Federal Reserve to raise rates around a year earlier than the status quo scenario (in 2025 rather than in 2026 under the status quo).

However, if we only see a White House switch (where Democrats fail to win the Senate, but Biden claims the White House), the overall policy stimulus will not be too different from the status quo scenario. Here Biden will face difficulties in implementing his policy agenda, although he would likely reverse some of Trump's immigration, deregulation and environmental policies implemented under executive order and adopt a more multilateral approach to international trade issues.

How would the economy perform under a Trump Presidency? Trump's agenda has been scant on details and given the House will almost certainly remain under Democrat control (~98% chance), the status quo situation will prevail. We would expect to see a compromised fiscal stimulus package passed following the elections, but the package would unlikely be much more than $1.0-$1.5 trillion, with the Democrats conceding many of their demands. Under this status quo scenario, Trump would continue his agenda on immigration, international trade and environmental policies through executive orders. However, we are unlikely to witness a significant change to the longer-term fiscal landscape.   

In short, the winners under a Trump Presidency will be corporate America, middle- and higher-income earners and the fossil-fuel energy sector. For Biden, the winners are likely to be immigrants/Dreamers, the environment, renewable/EV sector, low income earners, education, health and child/elder care recipients.

No matter who wins the election, the biggest risk to the outlook is the recent acceleration in COVID-19 cases. How either candidate deals with the intensifying health crisis will shape the course for the US economy over the coming year. Furthermore, given the near-term pressures facing the US economy, there is a risk that should President Trump lose, he won't act decisively enough during the lame-duck session. Waiting until after the inauguration in late January for Biden to deliver fiscal support, risks seeing the US economy slide backwards for a few months should the COVID situation continue to deteriorate.

Next Tuesday is shaping as a historic day. Our tip… Surprise Baby! No, not for the US election or the RBA, but for the race that stops the nation.

Table 1: Financial market movements: 22 - 29 October 2020

Source: Bloomberg