With less than 90 days left until the presidential election, Citi's Dana Paterson writes that the "election risks clock starts now." Here is how Citi previews the upcoming US election which "may generate extremely high uncertainty that likely will impose a significant drag on economic growth."
We are facing a watershed event in US politics, with both candidates presenting very low approval ratings and very unconventional profiles that offer divergent economic, social, foreign, and military policies to the US electorate. Policy uncertainty began to rise sharply when the very different prospective policy frameworks offered by the two candidates came into focus in the run up to the two party conventions. The extent to which uncertainty-induced drag persists will depend upon the ability of the new President and Congress to calm voter, investor, and global observer fears associated with the regime change.
As Citi writes, both Presidential candidates claim to offer economically stimulative policies.
- Trump presents the most extreme possibilities for fiscal stimulus and external drag from trade wars. Clinton's continuation of Obama policies has potential for surprising outcomes as well. The best case scenario would be an initial (perhaps prolonged) lift to economic activity from increased infrastructure spending and tax cuts. The worst case would be a recession, sooner rather than later.
- Despite the rhetoric, we believe a more benign, and most likely, scenario is a continuation of moderate US growth despite the uncertainty-induced drag in advance of the election. Congressional and judicial limits to Presidential power should moderate policy proposals that are enacted, relative to what the individual candidates hope to achieve. Nonetheless, we recognize that tail risks are myriad.
Hardly surprising that for Citi the best possible outcome is one where the status quo continues. But before we dig into the details of what Citi believes may happen under either candidate, we fast forward to what Citi sees as the potential black swans.
- We posit that the uncertainty stemming from polices proposed on the campaign trail may be muted by the safeguards built into the US political and judicial system.
- Checks and balances likely will transform aberrant polices enough to produce more reasonable and moderate economic outcomes.
- However, the track record of this election has been extremely unconventional. A post-election environment dominated by influential "outsiders" may weaken or overthrow many institutionalized safeguards against extreme Presidential actions.
- This may be a significant source of "black swan" events and further economic disruptions that justify prolonged and growing uncertainty well after the election.
This is a list of what Citi believes will be the upcoming black swans.
Here are the details:
From Mild GDP Lift to Protracted Recession: Scenarios, Caveats, and Tail Risks
The stated policies of Clinton and Trump suggest a number of permutations for the US outlook: Outcomes may range from a transitory mild lift in US economic growth to a protracted recession. Economic and political uncertainty drag notwithstanding, the policy decisions of the next Administration, coupled with the degree to which the President can work together with a divided Congress, will be instrumental for determining the path of US, and potentially global, growth.
We consider several potential economic scenarios under both Clinton and Trump Presidential administrations: (1) candidates’ stated unconstrained policies, but potentially least likely outcomes; and (2) Congress and Supreme Court constrained, but potentially more likely outcomes. We utilize a combination of our existing elections analysis, plus select data and assumptions compiled by other studies including those of think tanks, government agencies, and private institutions, to inform our views on policy outcomes, caveats and tail risks. We measure the economic impact of each candidate’s proposals according to what an unconstrained scenario might look like, versus what a more constrained reality might produce.
Below we summarize our assumptions and economic and policy outcomes, as well as those implied by various other studies including model simulation results of Moody’s Analytics under two scenarios:
- Unconstrained scenario: All of Trump’s/Clinton’s policies are implemented
- Constrained scenario: Trump/Clinton encounter limits to Executive power:
Trump: Slower US Growth and/or Recession
Unconstrained, and Less likely Outcomes: If Donald Trump’s stated policies are implemented in full, then we would anticipate a US recession, perhaps sooner, rather than later. There is some scope that Trump’s tax reduction policies (if legislated by Congress) might initially provide a temporary stimulus, but the downside from his trade and immigration policies could more than offset that stimulus. Moreover, the negative impact on capex expected reduced trade activity and labor market disruptions would be a blow to business confidence even before the trade and immigration policies are legislated and implemented. We note that many elements of Trump’s fiscal reform policies may become contractionary over the medium term (e.g. Trump’s focus upon sizable tax cuts, without specifics on offsetting reductions in spending, might lead to government crowding out due to outsized Federal budget deficits and Federal public debt).
- Trade wars would reduce net exports’ contribution to US GDP and business investment, and raise import prices. Global trade contracts further.
- Consumer spending likely would falter amid higher tariff-induced inflation and reduced confidence. Despite promises of lower taxes under Trump, higher induced precautionary saving probably would reduce tax multiplier effects.
- Combined with the anticipated drag from heightened uncertainty on capital expenditure, we would expect recession to occur sooner rather than later.
- The Fed likely would respond to a potential slowdown with additional accommodation, cutting rates and possibly reverting to using unconventional policies. Fiscal policy might become more stimulative as automatic stabilizers engage as activity slows.
Constrained, and More Likely Outcomes: Given the limits on Executive (Presidential) power that temper Trump's policy deployment, an extended period of slower US growth and easy Fed policy probably is a more likely outcome. Trump is limited in his ability to implement sweeping policies as Congress is likely to temper his more ambitious and controversial policy agenda items.
- Presidents can set an agenda and retain veto power over bills, but legislation originates in Congress: the House of Representatives and the Senate.
- Congress continues to be more focused on fiscal restraint than adding stimulus. Trump must contend with the more traditional, conservative policy agenda of Speaker of the House, Paul Ryan (R-WI) (assuming his likely reelection by his Wisconsin Congressional district in November, see Appendix 3. Election Calendar), who is arguably one of the most powerful legislators in Congress, apart from Senate Head Mitch McConnell (R-KY).
- We expect Trump to acquiesce to some of the Ryan agenda (as he did by adding a third (higher) tax bracket to his newly proposed fiscal agenda), but also test the limits of Executive Actions (EA), Executive Orders (EO) and other powers at his discretion to effect the policies he is most passionate about.
- Litigation and new legislation will be necessary to undermine and/or dismantle legacies of prior administrations (e.g. Obamacare, NAFTA). But Trump likely will agitate for actions on these fronts with the help of likeminded Congresspersons, assorted powers at the President’s discretion (e.g. Executive Actions (EAs), Executive Orders (EOs)) and/or the force of the will of the voters who supported him.
... As for Clinton:
Clinton: Continued Middling Growth and/or Slight Lift
The constrained (most likely) Clinton scenario features more of the same. We expect real GDP to continue to expand at a moderate pace, notwithstanding resistance from legislators (from across the political spectrum) to assorted Clinton proposals. However, the pace of growth could be reduced if prospects of more entitlement spending and regulation raise uncertainty and reduce investment.
- Clinton may have difficulty executing much of her stimulative agenda, which features expanded immigration; increased Federal government spending on infrastructure and domestic programs that increase incomes; and higher taxes for the wealthy and corporations. Fiscal hawks will resist larger deficits.
- We expect little to no change in existing trade deals, leaving US trade growth subject to existing headwinds. The extent of the rise in inflation may be more muted given our “continuation of moderate growth” scenario. Unemployment probably would remain in the range of full employment (4.5 to 5 percent).
- Financial markets, trading partners, and governments around the world likely would breathe a collective sigh of relief if Clinton becomes President. She has presented herself as the politically experienced, steady hand who can guide the nation (and possibly the world) through turbulent times.
- How left of center Clinton is once in office will determine the degree to which uncertainty drag diminishes post-election. Uncertainty could remain elevated or even increase if Clinton pursues the more populist aspects of her campaign platform (e.g. "America First" attitude towards trade, aggressively higher taxes, more intense regulation of the financial sector, leaning too hard on China).
Materially faster GDP growth with a Clinton win is an upside risk, in our view, as it would require few or no constraints to her agenda.
- US Growth may be fueled by implementation of more elements of Clinton's stimulative spending agenda and immigration liberalization, notwithstanding sizable tax hikes on high-income earners and corporations, as well as significant international tax reform. Over the long-term, immigration reform and infrastructure investment may boost productivity.
- Clinton bolsters consumer spending with wage initiatives, and lowers unemployment with education and paid family leave policies. Businesses may increase investment in response to firmer household demand and the positive effects of government infrastructure spending. The net exports contribution to GDP may improve if Clinton is able to negotiate the terms of the TPP to her liking and increase enforcement of “fair” global trade via existing agreements.
- Growth and headline inflation are notably higher, resulting in a somewhat steeper Fed Funds rate path and a potentially higher terminal policy rate.