October 28th, Caixin (Editor Xiaoxiang) With only a little over a week left until the U.S. presidential election, speculation about the outcome has been a hot topic in the market in the past few days. Although the latest opinion polls indicate a tight race in the key swing states, with support for Trump and Harris neck and neck, in recent weeks some gambling prediction platforms have clearly leaned towards the Republicans in the battle for the presidency and control of Congress.

Morgan Stanley stated in a recent report that the trend of the capital markets is roughly consistent with the pricing on prediction platforms. As reflected by the Republican Victory Basket (MSZZREP) and Democratic Victory Basket (MSZZDEM) they track, stocks influenced by a Republican victory have risen.

Note: The red line represents the performance of the Morgan Stanley Republican Victory Basket Index, while the gray line represents the Democratic Victory Basket Index.

Morgan Stanley noted that the sequence of potential policy changes after the election is crucial. When predicting market trends, investors may consider the scenarios that could arise if former President Trump were to win the election.

There are three main categories of policies, with tariffs possibly taking the lead.

Morgan Stanley believes that classifying the possible policy changes that may occur after Trump takes office into three major areas - fiscal policy, immigration control, and tariffs - seems reasonable.

In these three major areas, in order to make meaningful changes to fiscal policy, the Trump administration would need full control of both houses of Congress, and even in the case of a major Republican victory, legislation would take a significant amount of time. Therefore, in terms of the timetable for policy implementation, this area is likely to be the last among the three major areas mentioned above.

Due to the lack of details on how to implement immigration policy reforms, the timing of immigration policy changes remains unclear.

On the other hand, Morgan Stanley believes that considering the president's broad discretion in trade policy, Trump's expressed intentions in campaign information, and the precedent of his first term, tariff reforms are likely to take the lead...

In a report, Morgan Stanley economists and strategists assessed the impact of potential tariff increases on the economic outlook and markets. Their conclusion is that widespread tariff hikes imply a decrease in consumption, investment expenditure, wages, and labor income, which could bring downside risks to US economic growth and upside risks to inflation.

According to Morgan Stanley's estimates, if all the discussed tariff measures were implemented, it could delay US actual GDP growth by 1.4 percentage points and further drive inflation up by 0.9 percentage points.

Morgan Stanley states that some forecasting platforms believe the likelihood of a Trump victory is increasing. However, our evaluation suggests that a Trump victory would hinder GDP growth, raise inflation, so how should the US stock market respond? The market may underestimate the possibility that all proposed tariffs will be implemented in phases over a longer period, with some tariffs being implemented later than others. In addition, the market may currently place more emphasis on the 'animal spirit' recovery driven by expectations of regulatory easing, which is difficult to define or quantify.

Impact on the bond market

In terms of the bond market, Morgan Stanley points out that US Treasury yields have risen significantly recently, driven not only by the election results implied by the prediction market but also by other factors influencing the bond market. Strong wage and retail sales data undoubtedly played a key role, especially in the first two weeks of this month. However, despite this, the recent trends are likely driven by election prediction markets.

Many investors believe that a 'Republican sweep' result is most unfavorable for US Treasuries because after the Republican sweep in the 2016 election, the 2-year Treasury yield rose by 50 basis points within a month, and the 10-year Treasury yield increased by 80 basis points.

But Morgan Stanley's global macro strategy chief Matt Hornbach is not optimistic that US bond yields can surge after the election.

Hornbach pointed out that there are significant differences between the current monetary policy of the Fed and the monetary policy before the 2016 election, indicating that any increase in US bond yields this time will face more constraints. Compared to the market's current expectation of a 135 basis point rate cut in the next 12 months, the market was pricing in rate hikes before the 2016 election—by about 30 basis points. In addition, in the year following the 2016 election, market expectations for the federal funds rate target range rose by almost 125 basis points.

He said that if similar expectations of a rate hike by the Fed emerge this time, market participants will need to anticipate that the Fed will immediately stop cutting rates and will not cut further until the end of 2025. However, even in the scenario of a 'Republican sweep' in the election, this possibility seems remote...

Impact on the forex market

In terms of the forex market, Morgan Stanley expects the US dollar to strengthen after a Republican victory, especially against Latin American currencies affected by tariffs—such as the Mexican peso which is expected to rise. Due to strong US data, the Mexican peso was the best-performing major currency in the first half of October, but has since been weak, reflecting increasing attention to the US election results.

Additionally, the exchange rates of other currencies like the euro and yuan, which may also be affected by tariffs, could also rise.

Lastly, Morgan Stanley also stated, "Given the recent market trends and pricing expectations, if Harris wins, the market may deviate from the current trajectory, as they will have to change course. The election is a known unknown. According to polls, the competition in this election is still very intense, with a variety of possible outcomes for both the presidency and Congress. At the same time, one must also prepare for the scenario where determining the election results may take time. So, buckle up, we may be in for a wild ride."

Editor/Lambor