Analysis — Biden’s departure could spur Trump trade reversal, divided government in focus | WTAQ News Talk

Authors: Davide Barbuscia, Suzanne McGee and Matt Tracy

(Reuters) – U.S. President Joe Biden’s withdrawal from the presidential race on Sunday could prompt investors to pull back on bets that a Republican victory would increase fiscal and inflationary pressures in the U.S., while some analysts said markets could benefit from the increased risk of a divided government in the next administration.

The so-called Trump trade, which posits that the former president’s tax policies will boost corporate profits while undermining the long-term health of the nation’s budget, gained traction after Biden’s disastrous televised debate last month.

This was particularly evident in U.S. government bonds, with long-term Treasury yields — which move inversely to prices — briefly rising on heightened expectations that Republican presidential candidate Donald Trump would retake the White House following last weekend’s debate and failed assassination attempt.

Although yields quickly fell on signs of economic weakness, the move reflected investors’ belief that a Trump presidency could lead to inflationary policies and a more expansionary fiscal stance. But Biden’s decision to step aside and endorse Vice President Kamala Harris to replace him as the Democratic nominee undermines Trump’s victory and is likely to prompt investors to scale back those bets.

Trump’s team has said his pro-growth policies will lower interest rates and reduce deficits. Many market participants believe deficits will continue to worsen in a second Biden administration.

“It does put a damper on Trump Trade’s plans a little bit,” said Cameron Dawson, chief information officer at NewEdge Wealth in New York, but added that markets would wait for more clarity on who the nominee will be.

“Then we can expect a reversal of the Trump Trade trend and other moves of that type,” Dawson said.

A Reuters/Ipsos poll completed on Tuesday showed Trump with a narrow lead among registered voters – 43% to 41% – over Biden.

In accepting the Republican nomination on Thursday, Trump renewed his promises to cut corporate taxes and interest rates. Analysts also expect a Trump presidency to lead to a tightening of trade relations, which could result in inflationary tariffs.

Lower tax revenues could worsen the U.S. federal government’s budget deficit, which has been steadily rising for most of the past decade, including during Trump’s previous presidency from 2017 to 2020, although the increase in 2020 was mainly due to government COVID-19 relief.

Many investors believe the deficit will continue to widen in the event of a second Democratic term, but a more balanced election result could reduce the risk of excessive fiscal stimulus expected from a Republican victory in Washington.

Split or clean sweep?

Congress is currently divided, with Republicans narrowly controlling the House and Democrats narrowly controlling the Senate. Divided government is often seen by investors as a positive for markets because it makes it harder for either party to push through drastic policy changes.

Several Democrats had warned that Biden’s initial refusal to concede, which prompted some Democratic donors to close their spigots, would also destroy Democrats in the House and Senate races. But Biden’s departure would increase Democrats’ chances of controlling at least one of those chambers, said Brij Khurana, a fixed-income portfolio manager at Wellington Management Company, speaking before the announcement.

“If a divided government materializes, yields will be much lower than they are now,” Khurana said, as the bonds would reflect a potentially softer outcome for government debt issuance.

Jamie Cox, managing partner of Harris Financial Group, said markets could now re-price what had previously looked like a congressional victory.

“The Senate will likely go to Republicans, but the House is very vulnerable to a Democratic takeover,” Cox said.

Jack McIntyre, global fixed income portfolio manager at Brandywine Global Investment Management, also referred to divided government as a potential outcome and “positive for the market.”

EXPECTED VOLATILITY

Investors say market volatility could increase as uncertainty surrounding the election continues.

“A Biden resignation adds a whole new level of political uncertainty,” said Gina Bolvin, president of Bolvin Wealth Management Group. “This could be a catalyst for delayed market volatility.”

In recent weeks, many sectors of the stock market, especially small caps, have reacted positively to the prospect of a Trump victory. Cryptocurrencies have also risen on inflation bets.

The Cboe Volatility Index – Wall Street’s “fear gauge” – hit its highest level since late April on Friday.

“The market doesn’t like uncertainty, and the added element of an unknown Democratic candidate will certainly increase investor discomfort,” said Rafia Hasan, chief investment officer at Perigon Wealth in Chicago. “We don’t know what the market will do tomorrow and in the coming weeks on this news, so investors should be vigilant.”

(Reporting: Davide Barbuscia, Ira Iosebashvili, Matt Tracy, Suzanne McGee, Svea Herbst-Bayliss, Caroline Valetkevitch, Carolina Mandl, Saeed Azhar, Amanda Cooper; editing: Michelle Price, Megan Davies and Aurora Ellis)