Trump, Clinton and the Fed; they are going to change

Anyone planning to trade on Nov 8th deserves some sort of recognition for bravery. If there is one thing we can get from the polls is that there is still a very large margin of people who are undecided for whom to vote, and regardless of who is (or claims to be) in the top position, there are more than enough undecided voters out there to make the thing well and truly undecided.

So let’s get the simple bit out of the way first: As far as the markets are concerned, Clinton represents the status quo, while Trump change. So, conventional wisdom holds that if Clinton were to show potential for winning during the day, the markets will be optimistic; and if Trump shows like he’s getting ahead, the markets will likely be depressed. Mind you, Conventional Wisdom isn’t always as wise as he likes to think he is.

The relevant question is, well, what happens after? Whoever wins, the market is going to go up or down, and then we have to face the reality of new policy. Yes, even if Clinton wins, things are going to change. The thing is, our attention has largely been on news from the campaign – but, the reality of governance is vastly different from what happens (and is said) on the campaign trail. This is without the distorting effect of opponents and even allies trying to spin policy points and statements to make their own candidate look good (although more often it seems to make the other one look bad). Major campaign issues will most likely be simply forgotten once they no longer have the potential to pull voters. It happens every cycle.

Cutting through all the campaign fat and trying to get to the policy meat is a job for a while novel, let alone a little humble article like this. But if we are going to be trading the markets, we do have to focus on that particular aspect. And once the election is out of the way, the next event is the Fed rate decision.

Yesterday we had a relatively up-beat NFP release, and if there hadn’t been an election, most analysts would have been pretty sure about a rate hike following the December FOMC meeting. It had been promised all year – actually, more than one had been promised – and this is the last opportunity to deliver on the promise of plural rate hikes during 2016. Even if the timing is once again unorthodox; it would be the second hike in a row to happen in December – and that conventional wisdom we’d been talking about earlier says it’s not a good idea to raise interest rates in the winter.

So, how does the election affect the potential of a rate hike?

future

First, let’s not forget that the Chair has been – and the governors appointed affirm – a confirmed and persistent dove. To the point that it can be argued that she’s been using any excuse she can to put off rate hikes. You could argue that any market choppiness following the election regardless of results could be used as reason for staying on hold for a while. And to be fair, it’s understandable to be nervous about a rate hike that will take effect right after Christmas spending season. Even hawks who would have argued for a raise in summer might find a reason to delay at least until spring.

Secondly, we’re not completely through Q3 earnings season; although by Tuesday over 70% of the S&P500 will have reported, and the results are beating expectations so far, the underperformers typically come later in the season. Most 10-Q filing delays will be the week after the election. And then we have the revised NFP at the top of December. So a lot of the good data we have right now very likely could fade by the time the Fed decision comes around. Even with the electoral uncertainty over, we still have plenty of uncertainty ahead.

Even if we have a status quo result to the election, with Clinton taking a commanding number of votes, there is no guarantee of a rate hike. In fact, a very clear Clinton win might open up uncertainty as well – just a different kind. If the Democrats sweep Congress, the Obama-Republican deadlock is over and we have to start calculating the effects Democrat policy will have on the economy. And then you have to consider what will happen to a Republican Party reeling from a major defeat and divided over Trump. That level of political uncertainty wouldn’t be all that dissimilar from a clear Trump win, and could lead to significant depression the markets. That would be just the excuse Yellen would need to keep the rate hike on hold.

The most likely scenario to get a solid bump in the markets is for Republicans to keep hold of Congress along with a Clinton win. Traders and investors will see it as business as usual, and those who have been risk-adverse leading up to the election might be drawn back to the table. A positive bump in the market, and if the data continues to play out for the rest of the earnings, would make a rake hike all but guaranteed.

Now, if Trump were to win… well, he did say he was going to sack Yellen. How is this going to play on her psychology? Theoretically, she’d be professional enough to continue doing her job, and make decisions based on economic metrics. However, the market has calibrated Yellen’s outlook, and the potential of a new Chair in the future could lead to a certain amount of market uncertainty. Sure, Yellen might say the Fed will keep the rates low for “considerable time” – but what if her successor doesn’t share her view? Yellen’s ability to jawbone the markets will be significantly hampered. Especially since at this point we don’t know who would potentially be replacing her once her term was up.

On the other hand, if Trump were to win with a small margin – and even with that, Republicans can lose the Senate – the markets might be somewhat reassured that his most drastic proposals will be watered-down or at the very least he’ll be forced to continue with many economic policies already in place simply because he lacks the political wallet. Even so, the change will likely cause enough uncertainty to impact market outlook, and that might be enough to put a hold on a rake hike.

The final option is that Trump wins youge. With a strong voter showing, he’d have a strong political mandate to do…. well, we don’t know. And that’s going to make the markets pretty jittery. The only ameliorating circumstance is that Trump clarifies his policies in the days after the election, which could bring back confidence in the markets once we see will actually happen. But if markets don’t recover by early December, definitely no hike coming up; during the period of uncertainty following the election, it could affect outlook and have an impact on NFP. Even if you are Trumpkin and think that things will work out better in the end, you still have to admit there will be an initial shock, and that will be enough for the Fed to stand pat.

So, out of the four major scenarios, pretty much three of them will lead to Fed hold. If you add into that a Feb bias already towards hold, then things aren’t looking good for a hike. However that will depend on how likely each one of those scenarios are – and that’s anyone’s guess at this point.

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