US election risks: The Brexit lessons – Westpac

Research Team at Westpac, suggests that the parallels between the UK referendum and the US election run deep and lists down the lessons for markets that can be drawn from Brexit in the event of a Trump win.

Key Quotes

“A large scale political shock that arguably bears the closest resemblance to what may confront markets in the event of a Trump victory.

The parallels between the UK referendum and the US election run deep, indeed Trump has described the US election as “Brext times ten”. Clinton’s campaign and the UK  “remain camp” both represent continuity and an “establishment” approach to trade and immigration. The “leave camp” and Trump have been portrayed as insurgent outsiders tapping into economic insecurity and deep antipathy to governing “elites” who favour restrictions on trade and immigration. Demographic trends supporting each side (i.e. urban vs non-urban voters, college degree vs non-college degree) follow similar trendlines too.

The parallels extend to polling and prediction markets as well. The FT’s poll of polls in the days into the UK vote gave a 2pt spread to the remain camp (48%-46%), while Real Clear Politics’ poll of polls favours Clinton with a 2.9pt spread (47.2%-44.3%). Prediction markets are similar too – the remain camp was given a 20% probability in the days just ahead of the UK vote while Trump is about a 1 in 5 chance according to Betdata.

We can’t take the Brexit parallels too far though – the US tax code is set to undergo far reaching changes under a Trump win and much depends on the outcome of down ballot House and Senate races, neither of which were considerations in the UK vote. A Trump victory is arguably a bigger deal for the global economy and markets than Brexit too. The US’ hegemonic position in the global economy - the largest economy and the main reserve currency - ensures an outsized and potentially more sustained global impact from a Trump presidency than Brexit.

That said, what can we glean from the Brexit vote? The table highlights several key broad trends:

  • A surge in risk premiums will be the dominant short term reaction, understandable given that Brexit and a Trump presidency represent uncertainty incarnate;
  • A political shock like Brexit will leave a more lasting impact on some markets than others. As the table shows equities quickly recovered their poise within a month but interest rates and exchange rates - specifically gilt yields and GBP - built on their initial sharp decline in the hiatus period following the vote, awaiting fresh political news, signals from the BoE and some clean post-Brexit data updates on the economy;
  • It is not unreasonable to assume a similar “hiatus” period for markets in the event of a Trump win, as they await the new Administration to take its place (Jan 2017). The Brexit “playbook thus suggests that after the initial dislocation FX and fixed income markets will trade in new more enduring ranges, while equities and volatility indicators like the VIX and CVIX might regain their poise more quickly.”

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