US election primer: Navigating treacherous fiscal waters, no matter who wins

Asian equity markets found some relief as U.S. yields took a breather, though Japan wasn’t as fortunate, with a stronger yen weighing on local shares. In the U.S., futures held steady despite Tesla's impressive 22% surge on strong earnings, which gave the Nasdaq 100 a much-needed boost. The S&P 500 tagged along, notching a modest 0.2% gain. However, a lingering sense of broader U.S. election derisking seems to cast a shadow over "animal spirits."

Next week’s economic data could reveal more truths, but for now, all eyes are on the U.S. election drama. Trump is creeping ahead in the betting polls, although the mainstream ones still show a tighter race. Traders are trying to decide whether to ride the “Trump Trade” wave or prepare for some serious gridlock. Either way, traders are holding onto their hats.

Meanwhile, Japan is gearing up for its political showdown with the Lower House elections on October 27, and things are looking dicey. The ruling LDP-Komeito coalition might not get the 233 seats it needs to form a government without outside help, which could throw the country into a political blender. For Prime Minister Ishiba, it’s like walking a tightrope—if he doesn’t keep his balance, pushing through key policies like corporate tax hikes could be a nightmare.

But here’s where it gets interesting: if the opposition party, the CDP, pulls off a surprise and grabs more seats than expected (cue dramatic music), they could shake things up big time. The CDP wants to slash the BOJ’s inflation target from 2% to "just over 0%" and raise wages alongside tax hikes. It sounds like a recipe for yen strength and a headache for Japan’s equity markets.

And let’s not forget USD/JPY blowing past the 150 mark. Finance Minister Katsunobu Kato is ringing the alarm bells, warning of "one-sided" moves in the yen. Still, BOJ Governor Ueda seems to be in no rush to do anything drastic, coolly reminding everyone that the BOJ has time to figure out its next move.

Between election jitters and BOJ chess moves, Tokyo markets are probably in for a busy opening on Monday.

US election primer: Navigating treacherous fiscal waters, no matter who wins

 It’s still a razor-thin race for the “Blue Wall”—Wisconsin, Michigan, and Pennsylvania. But if I’m picking up the right signals, those in the know on the Democrat side are hitting the panic button. Their internal polling is flashing red, which means the battleground could be slipping away faster than they’d care to admit. Still, we’ve got to keep election risk front and center on the radar—things could swing quickly, and I’m not taking my eyes off it for a second.

Harris win

Under a Harris administration with Democrats firmly in control of Congress, you can expect a continued deficit spending spree paired with generous tax credits. This combo could sprinkle a modest boost to the economy, although higher corporate taxes might dampen business investment. So, while Main Street may get a slight lift, Wall Street might not throw a full-blown party.

Trump win

Flip the script to a Trump White House and a Republican-led Congress, and you'll see a recipe for tax cuts and deregulation, giving businesses plenty of breathing room. The trade-off? A ballooning budget deficit and the lurking threat of trade protectionism. While equities and the dollar could surge initially, brace yourself for higher inflation and interest rates down the road.

Gridlock

If the Democrats clinch the Oval Office but Congress stays divided, expect more of the same—gridlock that leaves the economic gears chugging along without much change. But if Trump retakes the presidency with a split Congress, get ready for a bumpy ride. Equity markets may face turbulence, with the uncertainty of increased trade barriers but no juicy tax cuts to cushion the blow.

Potential macro and fiscal impacts

No matter who holds the keys to the White House or Congress, the looming expiration of the Tax Cuts and Jobs Act in 2025 is the elephant in the room. Extending these measures would pile on an extra $4.6 trillion to the national debt by 2034, according to the Congressional Budget Office (CBO). Without an extension, American wallets could feel the pinch in 2026, potentially shrinking after-tax income by $290 billion, leading to a 4-point hit to annualized GDP growth in early 2026. Cue bipartisan action—don’t expect any politician to want to be blamed for tanking the economy.

Even before we toss new proposals into the mix, the CBO projects a massive 10-year cumulative deficit of $22.1 trillion, which will push federal debt above the post-war record of 106% of GDP by 2027, rising to 122% by 2034. If interest rates follow suit, the debt could spiral even faster, potentially spooking bond investors into demanding higher premiums. In the worst-case scenario, the U.S. could flirt with a debt ratio of 175% of GDP, a precarious tipping point warned by the Penn Wharton Budget Model. Though we’re not quite there yet, history tells us debt can skyrocket in tough times, as it did post-Great Recession and COVID-19.

Scenario 1: Democrats rule the roost

A Harris presidency with full Democratic control could drive federal debt to new heights, adding another $3.5 trillion by 2035. Initiatives like expanding tax credits for families, health insurance, and first-time homebuyers would lift the primary deficit by $1.2 trillion, with the corporate tax hike pushing it to $2 trillion(adverse economic feedback effects from raising the corporate tax rate from 21% to 28%). But hey, 95% of Americans might enjoy lower taxes, while the top earners pick up the tab.

Despite a bigger budget deficit, the economic boost would be more of a nudge than a shove. A proposed corporate tax rate hike from 21% to 28% could trim GDP by 0.6%, mostly through reduced business investment. Still, inflation and interest rates likely won’t spike dramatically.

Scenario 2: Republicans hold all the cards

Under Trump 2.0 with a Republican Congress, the federal debt could rocket by $7.5 trillion by 2035, nearly double Harris' plans. Trump's pledge to extend the 2017 tax cuts for households earning over $400k and slash corporate taxes to 15% would push debt to 142% of GDP. Remove the cap on state and local tax deductions (SALT), and you'd lose another $1.2 trillion over the decade.

Lower corporate taxes might give a slight bump to long-term GDP, but tariffs could spoil the party. A 10% across-the-board tariff would whack American consumers with an extra $300 billion bill while shaving off 1.1% of GDP. And if China is hit with a 60% tariff, that’s another $200 billion down the drain. The Peterson Institute warns that tariffs could completely undercut the benefits of Trump’s tax cuts. Expect initial stock market cheers to fade once the trade war drums beat louder.

Scenario 3: Democratic White House, divided congress

If the Democrats nab the White House but Congress remains split, the political tug-of-war will likely result in more of the same: minimal changes to the economy or markets. Business as usual.

Scenario 4: Trump returns, Congress is divided

Trump’s free hand on tariffs could trigger economic headwinds, especially if retaliatory strikes hit U.S. exports. The U.S. dollar might act as a buffer, but the disruptions to supply chains could push prices higher. Inflation or growth? The Fed would have its work cut out.

In this scenario, trade uncertainty could tank equities. Investors might hit the panic button without tax cuts to balance the hit from tariffs. And don't forget USMCA—Trump could reignite fears of ditching the trade deal, spooking business investments across North America.

Under the Trump administration, expect a rollback of green energy tax credits, particularly for electric vehicles (EVs). While a divided Congress might limit sweeping reforms, Trump could still deploy executive powers to pare down the Inflation Reduction Act’s credits.

Ultimately, no matter who wins, the U.S. will navigate treacherous fiscal waters. Whether it’s Harris with expanded tax credits or Trump with slashed corporate taxes, the only certainty is a bigger budget deficit.