Economics Global Economics & Strategy - How Will US Election & Vaccine Trajectories Shape Markets?

Two events in the next two months will significantly shape markets the next two years: (i)  the  potential  availability  of  a  vaccine  will  determine  how  quickly  consumption  can  ramp back up to aid the recovery (in Europe and the US, 23½mn previously employed people  are  still  'inactive'  or  unemployed);  and  (ii)  the  US  election  will  determine  how  much fiscal stimulus is possible, and potentially also whether there will be a new trade war with China. We construct updated scenarios for the three main election outcomes, as well as optimistic and pessimistic trajectories for vaccine approval and rollout.

This  is  partly  as  we  now  assume  a  $1½  trillion  stimulus  package  under  a  Dem  sweep  scenario,  with  tax  increases  delayed  until  2022.  That  lifts  US  growth  nearly  300bp  above  scenarios  where  Congress  is  split,  generating  a  'beta'  effect (6.2%  global  growth) that is roughly equal to the demand acceleration that would take place if the virus  count  fell  rapidly.  "Trump/status  quo"  and  "Biden/divided  Congress"  scenarios  are remarkably similar in their outcomes (global growth 150bp lower than Dem sweep) as  we  assume  trade  escalation  under  Trump  would  be  offset  by  somewhat  more  stimulus. A delayed rollout of a vaccine is, however, worse. This would leave DM with higher  unemployment  and  several  additional  years  of  output  gap  closure.  Monetary policy is maxed out. The policy delta is in fiscal policy and asset purchase programs.

Our  model  shows  that  the  median  contribution  of  vaccine  hope  across  regions  and  equity  factors  is  about  8.6%.  This  is  also an estimate of how much downside there is to equities in the worst-case scenario where  vaccines  are  not  just  delayed,  but  unsuccessful.  While  vaccine  hope  is  nearly  80%  priced  in  US  Growth,  it  is  only  46%  priced  in  US  Value  and  48%  priced  in  EM  Value. 

Into end-2020, S&P 500 is likely to do better under a Democratic sweep than under any other  scenario.  Into  2021,  however,  gains  are  likely  to  decelerate  significantly  as  earnings  are  hit  by  expectations  of  taxes  and  valuation  is  dented  by  higher  rates.  The  S&P  500  should  find  renewed  momentum  in  2022,  but  its  cumulative  two-year  gains  are likely to be superior under Biden with a split Congress. With high import multipliers of spending under a Dem sweep, global markets are likely to outperform the S&P 500. This outperformance is likely to be front-loaded though—S&P is unlikely to lag in 2022.

Supply only matters at extremes and we are at an extreme in the US. Over the next two years, 10y  US  yields could rise by over 100bp if a Dem sweep or early vaccine success crystallise. With a very different net supply position, Bund yields are likely to move with a beta of only 0.4-0.5 to US Treasuries. Liquidity will continue to explain credit spreads better than fundamentals. We see tighter credit spreads in most outcomes.

The low level of US real interest rates and high twin deficits make it likely that the dollar stays on the back foot, including, at least for the short term, against EM currencies. The exception  is  a  continuation  of  the  status  quo,  which  would  delay  dollar  losses  against  G10 to 2022, and could lead to sharp losses for EM. Biden with a split Congress should be the most positive for emerging markets fixed income

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