Financial markets are pricing in a cycle of widespread interest rate cuts. November’s US presidential election is now becoming the next major issue likely to influence the outlook for assets and market volatility amid high uncertainty over the outcome.
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US equities often do well in election years, while emerging Asia equities should, in our view, benefit from greater liquidity as US monetary policy is eased.
Rate cut cycle gains momentum
After recent interest rate cuts by the European Central Bank, Bank of England, Bank of Canada and Sweden’s Riksbank, Chairman Jerome Powell signalled clearly in his Jackson Hole address on 23 August that for US Federal Reserve, ‘the time has come’ for rate cuts. He said the Fed ‘will do everything to support a strong labour market’ while making ‘further progress towards price stability.’
The latest US employment report due on 6 September should give markets a better clue as to whether the Fed can start cutting rates by 50 basis points (bp) or 25bp in the policy meeting on 17-18 September.
Recent economic data has supported the growing momentum for rate cuts, notably the weakening in the US labour market and a sluggish European purchasing managers’ index (PMI). These numbers come on top of a continuing, albeit slower, decline in core inflation rates in many economies. Market speculation over a 50bp cut is not limited to the Fed; the Riksbank’s Board also discussed such a cut at its August meeting.
A wide cycle of rate cuts should benefit emerging Asia. The region mainly uses the US dollar for trade and investment transactions, effectively making it a dollar bloc. It has suffered from soaring real interest rates as local inflation has fallen while dollar rates have remained high.
US interest rate cuts should thus improve liquidity in Asia. With Asia’s inflation lower than that of many major developed economies (see Exhibit 1), the region’s central banks are well positioned to follow US rate cuts once the cycle begins.
Attention turns to the US election
Even as interest rates start to fall, domestic issues in the US may influence market sentiment and spark volatility. These could include political pressure on the Fed’s policy management, as well as worries over a fiscal crisis and the potential for social unrest. The risk of the latter creating market volatility should be monitored closely.
Speculation abounds over the Fed conducting its policy under political pressure before and after the election. However, despite the precedence in the late 1960s and 1970s, when the Fed (under Chairs William Martin and Arthur Burns) caved into political pressure and changed its interest rate policy, the central bank’s record under Jerome Powell suggests it should be able to remain politically neutral.
In 2018-19, the then-President Trump demanded the Fed cut rates. Powell ignored this. Recently, he reaffirmed the Fed’s stance that it would not take political events into account in its policy decisions.
Crucially, if the Fed were to be seen to be politicising its decisions, it would risk Congress (which has the power to confirm the Fed’s governors) moving to limit its independence – and thus its credibility. That should be a big incentive for the Fed to remain politically impartial.
Concerns over a US fiscal crisis are not new, but they may dominate market headlines in the run-up to the election. Neither candidate is fiscally conservative, which is accentuating concerns over higher government spending on top of a stubbornly high fiscal deficit. Furthermore, a long debate over tax policy is expected through 2025 due to the expiration at the end of 2024 of tax changes made by the Trump administration.
We believe the Fed’s rate cut cycle should underpin steady, though slower, economic growth, thus lowering the risk of a ‘fiscal cliff’ wreaking havoc on financial markets. Confidence in the US managing its fiscal deficit has remained high, as seen in the continued demand for US Treasuries and other domestic securities despite negative market shocks (see Exhibit 2).
Finally, the risk of social unrest appears significant, given pronounced political polarisation and the potential for electoral disputes. There is a non-negligible possibility of Trump being removed from the ballot if he is convicted of any of the various charges he faces. Alternatively, he might secure a decisive polling lead. Should either case unfold, the odds of unrest stirred by Trump supporters or opponents would rise.
Equity performance in an election year
Historically, US equities fare well in presidential election years, with the S&P500 index rising by an average 7.6% a year since 1960 (see Exhibit 3). Negative returns during election years were often the result of factors unrelated to politics, such as the economic recession in 1960, the ‘Dot-Com’ bust in 2000 and the Global Financial Crisis in 2008.
Ultimately, factors including trade and tax, regulation and geopolitics affect the outlook for markets. Policies around these topics will likely be contingent on the composition of Congress, which is uncertain at this point.
As monetary policies move towards more aggressive easing, they should provide a tailwind for global growth. With recession unlikely, in our view, we are positive on equities, with a preference for the US and EM Asia. We are also positive on European investment-grade credit and emerging market local debt.
