Last updated: 08:14 / Tuesday, 8 November 2016
According to Natixis

US Elections: The End of the Fed’s Independence?

US Elections: The End of the Fed’s Independence?

According to Philippe Waechter, chief economist at Natixis, on election day, the economic context continues to look uncertain. Growth in the US has been weaker in 2016, while the world economic outlook is on a moderate slope. World trade is not progressing much and fails to act as a growth driver for the US. In other words, if the US economy wants to get back on the path to growth, it will have to rely on its domestic market, rather than external impetus.

In this respect, he believes the two presidential candidates’ programs offer very different, and often vastly diverging, solutions:

  • In the Democrats’ program, as embodied by Hillary Clinton, the overall approach is based on the acknowledgment of the current long-term stagnation in economic growth i.e. a situation characterized by insufficient private demand to ensure robust growth, as well as by major revenue inequality. The solution put forward by Hillary Clinton is to implement an infrastructure investment program, which would be financed by more hefty income tax on the highest earners, thereby giving domestic activity a boost and hence reducing inequality in order to gradually eliminate the risk of long-term stagnation. The program’s aim is to put growth back on an upswing by reallocating resources towards infrastructure investment, and this increased investment should in turn heavily encourage private investment. The program would be financed by higher taxes, so the impact on the public deficit would be limited and the public debt profile would only increase very slightly, and probably not be much different to what is currently projected by the US authorities.
  • Donald Trump’s program takes a different take on the economy. It is based on two major principles: the first is to considerably cut back household and corporation tax in order to bolster domestic demand; the second is to give the United States back its power and independence of bygone days. This involves pulling out of trade commitments and treaties, and international political commitments, as well as the implementation of a more protectionist framework with a significant hike in customs duties, particularly with China. The overall aim is to drive the domestic market, while reinforcing the United States’ independence from the rest of the world.

The choice of candidate will have lasting and very diverging consequences for the economy. For the rest of the world, the impact will also be very different depending on who wins. If the Democratic party wins, we know that Clinton is not opposed to free trade, although she is not a fervent supporter either (particularly the TTIP), so in other words she will not take protectionist measures but neither is she like to force greater trade agreements between countries or zones. From a political standpoint, the role the US plays in the worldwide equilibrium would continue.

If the Republican candidate is wins, then the situation will look very different. The shock on world trade would affect all participants in the world economy, driving activity down. No-one will escape this negative shock, and in particular China. Canada and Mexico, which do considerable trade with the US, would also be penalized, and Europe would also be affected by this radical change. The other point to note is that the Republican candidate does not want to see the US guarantee world security, contrary to the situation we have witnessed since the Second World War, and this would cast doubt over NATO membership. There is a risk that this situation would create a context for mistrust and suspicion, which is never good news for growth.

At Natixis, from a tactical standpoint, they maintain a considerably more positive stance on equities than bonds, based on:

  • projections for world growth that are still weak but downward risks are easing;
  • extreme valuations on the bond market, even after the rise in rates seen since the start of September;
  • the feeling that Eurozone investors should gradually factor in the upward inflationary trend out to mid-2017 and the likely announcement from the ECB in December of a less generous approach to its quantitative easing program during 2017, thereby promoting an upward normalization of long-term rates.

"In view of the likely Hillary Clinton victory, we maintain a positive view on emerging markets, particularly on emerging debt, once the rise in short-term US bond rates and the dollar has been processed." Says Nuno Teixeira, Head of Institutional & Retail Solutions Investment and client solutions investment division.

The end of the Fed’s independence?

The two candidates’ attitude on the Federal Reserve is also very different according to Waechter. "We can expect few changes from Democrats: the candidate would guarantee the Fed’s independence and Janet Yellen could seamlessly continue to manage US monetary policy. The Republican candidate’s approach is radically different. This can be seen in the vast number of criticisms of Janet Yellen’s strategy. The danger is that he could attempt to reduce the Fed’s independence, either heavy-handedly by changing the law, or by revisiting an objective from Republicans in Congress to cut back the central bank’s leeway, all with the aim of forcing the Fed to follow precise rules in its management of monetary policy. The Fed could still be independent in legal texts, but in practice it would not be." He concludes.