UBS attempts to analyze the 4 possible outcomes of the US election, in the latest note by CIO Mark Haefele, and how they will affect European investors, businesses and politicians. And as the US election draws ever closer, he concludes, he sees two key issues coming to the fore: trade and defense.
As Haefele explains, the US is the EU’s largest trading partner in terms of both exports and imports. In addition, its role as a supplier of energy and related products to the EU has increased since the Russian invasion of Ukraine.
The assessment is that in any scenario, there is a very low chance of a major trade deal between the EU and the US. Instead, the focus would be primarily on any protectionist moves by the US that might arise, be it trade tariffs or other measures (the EU is unlikely to be proactive). In the medium term, however, UBS expects any changes to be marginal.
On defense, Europe has already increased its share of defense spending in an effort to meet earlier NATO commitments of 2% of GDP spending, but many countries still have some way to go.
With budgets across the continent facing a period of consolidation following a significant increase in spending during both the COVID pandemic and the energy crisis, further pressures to increase defense spending or raise it to a higher level could face challenges.
In addition, if Europe diverts more funding to Ukraine to compensate for reduced US support, we could see additional pressures on the economy in the absence of an end to the conflict, UBS estimates.
Essentially, a Biden presidency would largely represent continuity, and potentially a more predictable policy path, in UBS’s view, so this scenario would prove less challenging for investors.
A Trump presidency potentially creates more uncertainty, which, once the dust settles, could have both upsides and downsides for investors.
And a president’s difficulties with a divided Congress could produce an outcome that falls somewhere in between. One constant, whatever the outcome, is that Europe will likely need to devote more resources to defending itself, UBS reports.
The scripts
Blue sweep – Democrats win the White House and both houses of Congress
UBS expects US growth to be slightly weaker, with consumption slowing as a result of tax increases on higher-income households. Weaker growth would be consistent with a continuation of the deflationary trend.
He would not expect these trends to affect the economic outlook for Europe, with inflation expected to normalize and ECB interest rate cuts to trigger a recovery in activity by 2025.
Fiscal risks should also be contained as concerns over NATO and Ukraine funding are likely to ease, giving national governments more room to consolidate.
Biden with a divided Congress – Republican Senate and Democratic House
Without the possibility of substantive legislation being passed, UBS expects this scenario to be relatively neutral for growth, inflation and US Fed policy.
Therefore, the impact on the European economy should be reduced, especially since the two main areas of focus (trade and defense) are not likely to change with Biden continuing as president.
Under this scenario, UBS expects falling inflation and interest rate cuts to support a moderate recovery in economic activity.
Red sweep – Republicans win the White House and both houses of Congress
In this scenario UBS expects lower taxes than under a Democratic president, as previous tax cuts will likely be extended. This may lead to modestly higher US GDP growth, but could also mean that inflation rises, limiting the scope for US interest rate cuts.
For Europe, firmer inflation and a stronger US could limit the ECB’s willingness to ease interest rates, especially if this scenario resulted in a substantially weaker euro.
But the biggest concerns for Europe will be trade and foreign policy. Europe will likely react to any change in trade tariffs, potentially limiting how far the US president would like to go in trying to curb European imports.
In UBS’s view, any change in trade tariffs should be limited and have a marginal impact on the European economy. However, in the short term the potential risk from the uncertainty may outweigh the ultimate impact.
Defense spending may be a bigger concern. Any significant increase would mean more borrowing by national governments or a reallocation of resources from other growth-enhancing sectors. Both would likely put downward pressure on economic activity in the medium term.
An important caveat here is that some defense spending can lead to productivity-enhancing innovations as they spill over into the real economy (the Internet is a clear example).
Increased European funding for Ukraine is another pressure, not only from a fiscal point of view, but also affecting consumer sentiment. However, it is not entirely clear that more funding will need to be met from national budgets. Creative solutions for using idle Russian assets in Europe to finance Ukraine could attract more attention. In addition, a joint program could also emerge with EU support from member states.
An important aspect of the “red wave” may be that imported energy prices for Europe continue to fall, with decarbonization plans being relaxed by the new Republican president resulting in more supply. Such an outcome could have a positive impact on consumption in Europe, offsetting some of the burdens on trade and defence.
UBS’s sense is that the outlook for growth, given competitive factors, is likely to be marginally negative. This means that deflation continues and the ECB will end up deciding on slightly lower interest rates to support the economy
Trump with a divided Congress – Republican Senate and Democratic House
In this scenario UBS expects the economic impact to be broadly similar to the Red Sweep scenario, although US growth may not be as strong.
In addition, there is a risk that a president disenchanted with domestic politics will strengthen areas where he has discretion. i.e. foreign policy, trade and regulation by executive orders.
Impact on markets
The overall impact on the stock market from the various scenarios is unclear, UBS notes, with a more supportive environment for growth under the Trump administration likely to coincide with higher inflation, higher interest rates and potential trade tariffs. Given the sensitivity of equity markets to gauge expectations right now, they may not respond as strongly to a Trump victory as they did in 2016.
Against this backdrop, UBS sees the biggest impact for European equities more at the sector level.
On the bond front, in UBS’s view, a Biden victory or a “blue wave” would prove to be the most supportive scenario for fixed income markets. With deflation continuing in the US, interest rate cuts and lower government bond yields in the Eurozone are likely to follow – largely in line with consensus expectations.
As fiscal pressures remain contained at the government level and disruption in the corporate sector also remains limited, the broader European fixed income markets are expected to produce solid total returns overall.
A Trump victory could cause turmoil. With markets still pricing in rate cuts of 75-100 basis points in both the US and the Eurozone for this year, with further easing expected in 2025, persistent inflation and a recalibration of interest rate cut expectations would likely lead to some interest rate volatility, potentially undermining sentiment and disrupting inflows into fixed income markets.
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