Following a shaky debate performance from Joe Biden, Donald Trump is now the clear frontrunner in this year’s race for the White House. The incumbent president lost his train of thought, raising questions about his mental fitness and ability to serve another four-year term. The immediate reaction to the debate was that Mr Biden would be forced to drop out. Those rumours were amplified by polling this week, showing Mr Trump widening his lead on a national level. Using the Real Clear Politics average of national polling, voting intentions for Mr Biden dropped by 1.3 percentage points after the debate. Increasingly, the question now seems to be when will President Biden bow out and who will replace him, rather than if he will.
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The large move in political sentiment allows us to assess how investors are currently pricing a second Trump administration. One of his administration’s most notable economic policies was a large corporate tax cut, implemented as part of the Tax Cuts and Jobs Act of 2017. That, alongside a generally loose fiscal position, helped lift US equity markets to strong gains. Whether investors expect that from a second term is unclear. Both the S&P 500 and Nasdaq dropped immediately following the debate, but have since posted gains. With the effective corporate rate historically low, it will be harder to lift equity markets higher via this route.
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From an economic standpoint, Trump’s first term was associated with fiscal stimulus and deregulation as well as increased protectionism, and that seems like a good initial playbook for a potential second term. Mr Trump is in favour of lower taxes at home, but has mooted a 10% across-the-board tariff on all US imports, with duties as high as 100% on imports from China. That combination would be likely to, all things being equal, increase inflationary pressure. Indeed, one-year inflation-linked swaps increased by almost ten basis points in the immediate aftermath of the debate, before reversing course somewhat.
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A more speculative impact is that a second Trump administration may influence the Federal Reserve. Mr Trump famously jawboned Fed Chair, Jay Powell, during his first term, calling for lower interest rates. Some investors believe these calls would become greater, particularly given the sharp increase in interest rates in recent years and market expectation of a period of higher-for-longer interest rates. Mr Powell’s term is due to expire in 2026 and he could be replaced by a dove. The WSJ has reported that Trump’s inside team is looking into options where he could even play a role in setting interest rates himself. All of this is speculative, but it would be consistent with a steeper yield curve as the front-end is kept artificially low and the long-end is forced to compensate. There has been a move consistent with that, with the ten-year minus two-year spread increasing by almost 15 basis points.
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Another area to observe policy change is climate. Mr Trump announced the US’s withdrawal from the Paris Accord within months of his first term. Trump then blasted many aspects of the Biden administration’s approach to the green transition, calling them a “green new scam”, with particular ire aimed at mandates for electric vehicles. Nasdaq’s Clean Edge Green Energy index aims to capture ‘manufacturers, developers, distributors and/or installers of clean-energy technologies’. It fell by almost 3.4%, relative to the Nasdaq, immediately after the debate, but has more than reversed course since then.
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Assessing the picture overall, the clearest immediate impacts were on short-term inflation expectations and the yield curve, as well as green energy. However, most of the impact appears to have been short-lived. Part of that may reflect uncertainty around what precise policies will be implemented, particularly as the economic backdrop now, with recent high inflation and interest rates, is very different to the one inherited in 2017. That may limit Mr Trump’s options. A more plausible explanation for the reassessment in markets is that investors came to understand that the odds of a second Trump presidency may not be much different this week when compared to last. While Mr Biden’s odds have dropped sharply, this reflects the probability of him being the nominee. If he is replaced by a more popular candidate, we may look back on the debate as a key moment that lowered the odds of Mr Trump winning. We will continue to assess the race for the White House and its implications for investors.
The views expressed in this article are the views of the author, not necessarily those of LSEG.
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