Key takeaways
- There is growing consensus in Washington DC that the ‘phase one’ US-China trade deal due to be signed in November will include the cancellation/postponement of planned December tariffs. The tail risks remain stacked to the downside though with wide agreement that President Trump will make the decision himself and predicting what he will do is very difficult.
- The Democratic primary race is too early to call. It is considered a “2+1” race: there are currently two frontrunners, centrist Joe Biden and left-wing Elizabeth Warren but there is still time for an additional candidate to break through the pack. Names cited for such a breakthrough include moderates who could benefit from a Biden underperformance and concerns about Warren’s electability. These include Pete Butiegieg, Kamala Harris, Amy Klobuchar and Corey Booker. Key waymarks for tracking the race include Thanksgiving, when the race often consolidates, and January when a dark horse could still break through.
- While investors are increasingly nervous about Warren’s left-wing policy agenda, her ability to pass transformative policy is likely to be limited by Congress. Firstly, the path for Democrats to get a majority in the Senate is difficult, though not impossible. Secondly, even with a slight majority in Congress, the Democratic party is a broad church of centre-left and left-wing voters and representatives. So, while corporate taxes would be likely to rise and social welfare rise, big ticket policies like Medicare-for-all would remain challenging to get consensus on.
- Companies in the technology, financial, pharmaceutical and fossil-fuel production sectors would be likely to come under regulatory pressure under any Democratic president. The President has the power to appoint regulators and pass regulatory changes by executive order. While markets may take fright on the regulatory environment, Warren’s policy agenda may present a boost for some elements of the US economy. Indeed, her focus on employment, social welfare, antitrust legislation and green infrastructure may provide support for welfare, consumption and productivity in the US.
Trade policy ceasefire to hold?
The US and China have agreed a trade truce, following an alarming escalation in tensions over the summer. Proposed tariff hikes for October have been suspended – seemingly permanently – and reports suggest that progress is being made towards a mini-trade agreement. This is being heralded as the first phase of a broader deal. We have been down this path before, with a cooling in tensions both late last year and in spring proving to be false dawns. However, the expectation in Washington was that this edition will prove more durable.
The mini deal cobbles together those areas in which it has been possible to find agreement. This includes agricultural goods purchases, modest concessions on intellectual property protection, greater market access for US financial services and principles on currency intervention. A resolution mechanism is also reportedly under consideration, but is seen as a stickier topic which might fall out of this phase.
This stops short of addressing deeper concerns over unfair trade practices and in particular industrial policy. However, while there remains bipartisan support for a tough line on China, our contacts highlighted that it would be hard for Democrats to outflank the President on trade. Instead, they expect the president to try to sell this deal as a win, and promise further action in the future (although nothing of substance is expected to be delivered).
Moreover, there have been signs of a hardening in China’s trade position. Indeed, a former member of the administration’s trade negotiating team commented that the window for a broader agreement had been open in the spring, but has since closed. Certainly with an election on the horizon, it was considered unlikely that Chinese policymakers would make major concessions. The feeling was that this was the best deal available to the US.
The mini agreement, if signed, is likely to cancel the December round of tariffs. Our contacts believe that there has been strong and consistent messaging from advisers against implementing this tranche, which would fall more heavily on consumer goods that the US imports solely from China. The President has thus far been adamant that tariffs do not harm the US economy. However, nervousness around the effect of these levies is likely to grow as we enter an election year.
Many were struck by the degree of political capital being invested in this agreement. President Trump has built this up in typical fashion, while key advisers including Kudlow, Lighthizer and Mnuchin have all fallen into line behind negotiations. While U-turns have become common and should not be ruled out, everyone we spoke to saw clear momentum towards an agreement at the Asia-Pacific Economic Co-operation (APEC) meetings in Chile.
However, while progress is seemingly being made towards averting further tariff hikes, the mood was still pessimistic around the long-term structural conflict between the two superpowers. Indeed, there was little confidence that we would see progress towards a phase two agreement, which would deliver deeper reform in exchange for tariff relief. Moreover, the expectation was that we would continue to see non-tariff trade barriers erected.
While phase one of the agreement is likely to include the release of licenses for US suppliers of Huawei, significant non-tariff tensions are expected to remain, particularly in the technology sector. The table below highlights the key channels through which these tensions are likely to surface, on both the US and Chinese side. While the impact of these measures may be more company specific, they clearly can have long-term impacts on sectors and supply chains.
Table 1: Non-tariff action set to escalate
Our view: Overall, it now looks more likely that the US and China will sign a mini-trade agreement, which could help avert the final hike in tariffs currently scheduled. However, we will need to watch negotiations closely for signs of a snag, especially given recent precedents that suggest the risks around this view are tilted towards another flare up in tensions. Avoiding the final round of tariffs would clearly be positive for corporates and households, although we need to be careful not to expect too much in the way of an economic boost. Following recent experience, the uncertainty around trade is likely to remain elevated, providing a continued disincentive for investment. Furthermore, there looks to be limited scope for agreement on deeper issues around the trade agreement, and hence little chance of widespread tariff relief. Instead, the conflict is likely to shift towards non-tariff barriers, which pose their own challenges for affected companies and sectors.
While Warren and Biden are the frontrunners, the Democratic Primary race is far from over
Contacts in Washington are broadly agreed that the race for the Democratic nominee for president is a two-horse race at this point, but with space for a late ‘dark horse’ to emerge. October is still early in the Democratic primary campaign, with Thanksgiving and January pointed to as key waymarks for candidates to consolidate support and change the race.
Centrist Joe Biden and left-wing Elizabeth Warren are polling neck and neck, reflecting the wide range of political views among Democratic voters. While Bernie Sanders is in third place in the polls, nobody sees him as viable to overtake Biden and Warren. Instead, moderate names like Pete Butiegieg, Kamala Harris, Amy Klobuchar and Cory Booker were flagged as candidates who may have a late lift in support if Biden continues to underperform and Warren is ultimately deemed too risky for the Democratic party against Trump.
The first primaries, in Iowa and New Hampshire, are symbolically important for the Democratic candidate as most successful nominees in the past won at least one of the first two states to vote. However, some analysts pointed to Biden’s popularity with black voters as reasons for him to do well in the Southern states that follow Iowa and New Hampshire. The crucial question is whether an alternative moderate, like Buttiegieg, wins one of the first two primaries; this would be a strong negative signal for Biden as it would mean an alternative centrist has come to the fore.
The factors determining the primaries include whether it is open to non-Democrat voters or closed; a caucus (a meeting where voting is done by raising hands or breaking in to groups) or a primary (traditional voting booths with private ballots); the ratio of black and white voters; education and socio-economic status of voters. Biden is expected to do in open primaries with greater proportions of older, less educated and black voters. Warren should do better with closed caucuses with greater proportions of young, college educated and white voters.
Table 2: Democratic candidate support statistics
Elizabeth Warren’s policy agenda is making markets nervous; investors should watch the Congressional elections just as closely
While the race remains open, the debate mostly focused on Warren’s policy agenda and electability, given her more progressive policy platform. Her policy is focused on taxing corporate profits more heavily, fighting against monopolies and market concentration in order to boost competition (particularly in technology and financials), creating a public-only healthcare system and free tertiary education, and expanding social welfare (see Table 2 for details). These policies would clearly create winners and losers in the US corporate sector.
One of the striking elements of Warren’s agenda is that for key issues like healthcare, education, social welfare and taxation, Congressional approval is needed. The House, where the Democrats have a majority, and one third of the Senate, where Republicans currently have a majority, are up for re-election in 2020.
The path for Democrats to win the Senate in 2020 is visible but very narrow. The best prospects for picking up seats are Arizona, Colorado, Maine and North Carolina. However, the Democrat-held Alabama and Michigan seats are at risk. The role of the presidential race is key for Congressional outcomes: US voters have increasingly voted for the same party across White House, House and Senate so a strong win by a Democrat in the Presidential election in a given state increases the likelihood of, but does not guarantee that, a Democrat wins the Senate seat.
Even if the Democrats get to a simple majority in the Senate (51 seats including the Vice President), Warren’s more ambitious policies like healthcare and education were flagged as highly unlikely to pass the Senate as even Democrats are deeply divided on these issues and a two thirds majority is needed for transformative policy change. Moreover, it was seen as relatively unlikely that the Senate would pass legislation removing the filibuster in order to allow legislation to pass with a simple majority. Changes to the reconciliation process could allow more leeway, but this is still expected to limit legislative ability of the Senate.
However, Warren’s main impact on corporates in the technology, financial and pharmaceutical sectors would be via regulation. Here, the president has the power to appoint regulators and pass regulatory changes by executive order. Some of our contacts highlighted that regulatory changes could be challenged in the courts system, which is dominated by conservative judges as a result of the Trump presidency.
However, interpretation of existing regulation and stringency of regulators appointed by the president can have a significant effect on corporates, even in the absence of substantive regulatory change. Indeed, even if Biden or an alternative moderate was to win the Democratic nomination, they are also likely to follow a similar regulatory approach.
Our view: We expect 2020 to create significant policy uncertainty for investors if Warren gains traction and wins the nomination. We would expect healthcare insurers, pharmaceuticals, large technology firms, financials and fossil fuel producers to be under particular pressure as investors try to assess the risks a Warren win could bring to incumbents’ business models. However, we are sceptical of her ability to pass transformative legislation unless the Democrats take the Senate, so close monitoring of key states will be crucial when the election draws closer. Even then, a slim majority should limit legislative leeway. Nonetheless, regulatory pressures on corporates are likely to ratchet up, particularly relative to the current Trump administration. On the other hand, while markets may take fright on the regulatory environment, Warren’s policy agenda may present a boost for some elements of the US economy. Indeed, her focus on employment, social welfare, antitrust legislation and green infrastructure may provide support for welfare, consumption and productivity in the US.
Table 3: Warren policy agenda