Global Insights
Scenarios and implications of the US election for Europe
ElectionWatch 2024
President Biden’s abrupt decision to withdraw from the race in July and endorse his vice president has altered the dynamics of the forthcoming US presidential contest. Europe needs to prepare for the prospect of a new president.
It only took three weeks for Kamala Harris to garner enough support from fellow Democrats to be anointed as the party nominee. Moreover, Harris’s fundraising during this period outpaced that of former President Trump, giving her campaign a further boost. The consequences of the Democrats’ switch from Biden to Harris are still unfolding, but it is clear the momentum of the presidential race has shifted significantly.
Recent opinion polls suggest Harris is better positioned in a head-to-head contest against Donald Trump. She has gained more than 6 points in national polls and improved on Biden’s position by a similar margin in some of the critical swing states. Meanwhile, former President Trump’s prospects in some states that lean Democratic, such as Virginia and Minnesota, have dissipated in recent weeks.
Harris still faces the task of defining herself and her policy platform for uncommitted voters. However, the abbreviated campaign probably helps Harris as it allows less time for Republican critiques of her policy positions to alter perceptions. To reflect the shifting momentum of the presidential race, we have adjusted our probabilities to account for the moves in likely voter behavior and will continue to monitor developments in what is shaping up to be a spirited contest.
Significant market implications emerge from the stark contrast between the presidential candidates’ policies. While we believe portfolio construction should be an apolitical process no matter how distracting the lead-up to Election Day may be, here are our policy, economic, and market expectations for the most likely outcomes.
As things stand, the probabilities of Harris winning the White House are now higher than for Trump, but this is marginal given the highly divided electorate. Although momentum is currently with the Harris campaign, it should be noted that historically, national polling has not been a reliable predictor of presidential races. In part, this is due to the tendency for such polls to underestimate support for the Republican Party. This election will likely be decided by a few key swing states, in which Harris’s lead in the opinion polls looks less dependable.
With the Oval Office set for a new resident early next year, in this report we look at what the consequences could be for the European economy and investors.
Kamala Harris joining the presidential race does not alter the two key issues that European investors, businesses, and politicians will need to navigate: trade and defense.
The US is the EU’s largest trading partner in terms of both exports and imports. Moreover, its role as a supplier of energy and related products to the EU has grown in importance since Russia’s invasion of Ukraine. Our expectation is that under any scenario, there is a very low chance of a significant trade deal between the EU and the US. Instead, the focus would primarily be on any US protectionist moves directed at Europe, which could happen under either candidate. And this doesn’t only concern bilateral trade between the EU and the US. US policy toward China has also affected the EU’s approach to trade with the world’s second-largest economy.
From what we know of the campaign so far, a Harris presidency should largely represent continuity, and potentially a more predictable policy path on defense, with a commitment to a multilateral approach to tackling conflicts, and on trade policy. All else equal, this should prove less disruptive for investors, and pose lower risks to economic growth in Europe.
In contrast, a Trump presidency potentially creates more uncertainty, which could have both positive and negative implications for investors after the dust has settled. In our view, Trump is likely to take a more unilateral and transactional approach to foreign policy and trade. Starting with the impact on trade, we view the more extreme tariff measures mooted on the campaign so far (e.g., a 10% tariff on all imports) as credible initial threats to achieve the former president’s goals to reduce the trade deficit and promote US manufacturing, even if such a move is eventually relaxed or scaled back. How long this would last would depend on how quickly the EU reacts and the results of what are likely to be tough, drawn-out negotiations. Such policies or even the mere threat of them have the potential to cause, at least in the short term, significant volatility in markets and weigh on business confidence and investment from an economic perspective. In our view, a Trump administration poses a number of downside risks to the European economy in the short term, but this could be offset in the medium term if rerouting of supply chains results in greater investment on the continent.
Turning to the question of defense, irrespective of the outcome of November’s presidential ballot, European countries are already aware that they need to devote more resources to defending themselves in the coming years, as long-term US support can no longer be assured. To be sure, Europe has already increased its share of defense spending, as it attempts to meet previous NATO commitments of 2% of GDP, but many countries still have some way to go. With budgets across the continent facing a period of consolidation after a significant increase in spending during both the COVID-19 pandemic and the energy crisis stemming from Russia’s invasion of Ukraine, further pressure to speed up defense spending, or take it to a higher level, could face challenges. In addition, if Europe were to divert more funding to Ukraine to make up for waning US support, we could see additional strains on finances in the absence of an end to the conflict. Even in countries with relatively healthy finances such as Germany, political pressures are starting to raise questions about how willing and able Europe is to run larger-than-usual deficits.
For questions around defense, the US election potentially matters for timing rather than destination. In our view, a Trump presidency increases the risk that spending needs to be ramped up sooner, while a Harris presidency may give Europe more time. In terms of the economic impact, the immediate need to divert government resources in the short term could have a negative impact, especially as Europe lacks sufficient domestic defense manufacturing capacity. However, investment in this area could produce long-term economic benefits, not just from increased capacity, but also the increased productivity that can result from innovation in this space.
We expect much of the impact on European equity markets to be beneath the surface—i.e., at a sector level—rather than see any of the four scenarios above as meaningfully more positive or negative for equities overall. Under a Trump-led administration, we believe the focus will be on trade tariffs, lighter regulation, a push for lower taxes, partial rollback of specific IRA (Inflation Reduction Act) incentives, and pressure on the EU to increase military spending.
Under this scenario, the energy and financial sectors should benefit from a more relaxed regulatory environment, especially those with high US exposure. This, however, may be less helpful for more domestically oriented European banks, which could lose further competitiveness relative to US peers. Lower taxes in the US for higher-end consumers could be supportive for Europe’s luxury goods companies. Businesses benefiting from higher European military spending should also do relatively well.
If a Trump presidency is successful in de-emphasizing some aspects of the IRA and other sustainability and green energy initiatives, it may weigh on Europe’s industrials and utilities companies, as well as European EV manufacturers. Higher trade tariffs, or the threat thereof, would also be negative for stocks with direct export exposure to the US, like European automobile manufacturers, or those closely tied into supply chains. However, over the medium term, this could potentially accelerate investment trends globally as supply chains are reconfigured, which could end up favoring European tech and industrials companies.
A Harris-led administration is likely to largely be a continuation of the status quo, favoring climate change initiatives, which should be helpful for Europe’s greentech leaders in the industrials, utilities, and auto manufacturing sectors. We see lower potential for a negative impact on healthcare stocks in this election than prior ones, although they could be at risk from drug pricing negotiations under a blue sweep scenario. That said, the higher likelihood of a split Congress reduces this risk somewhat. Previous discussions of a menthol ban in cigarettes is also a risk for sentiment toward tobacco companies if this is pursued by a Harris presidency. Finally, we suspect that any tax or entitlement changes by a Harris administration will be beneficial for lower-end consumers, favoring European companies more exposed to this segment.
In our view, a Harris-led administration should prove to be the most supportive scenario for European fixed income markets. Disinflation in the US and European economies is likely to continue largely uninterrupted, which should allow central banks to stick with the interest-rate cutting cycle. This should pull government bond yields lower—largely in line with consensus expectations. Although budgetary strains are common among European governments, from an investor’s point of view they remain largely contained to France, Belgium, and Slovakia (see Stress-testing EMU and US government debt, 5 June 2024). In addition, we see little reason to expect significant disruption in the corporate sector, which implies that broader European fixed income markets can generate solid total returns overall under this scenario.
A Trump presidency, however, could prove to be more disruptive for fixed income markets. In recent weeks, markets have shifted to pricing a relatively steep start to the US rate-cutting cycle, with further easing expected in 2025. Several of Trump’s policy proposals carry the threat of more persistent inflation, which could result in a recalibration of expectations for rate cuts. This could lead to some volatility in rates markets, potentially undermining sentiment and disrupting inflows into bonds. In addition, given former President Trump’s musings on the Federal Reserve, there may also be increasing concerns about the independence of the Fed. In our view, while criticism over the Fed’s handling of monetary policy almost certainly would increase in a second Trump administration, we do not believe a substantive shift in responsibility to the executive branch is likely. However, that doesn’t mean that investors will ignore the prospect entirely, which could see risk premiums on bonds rise.
Finally, given the desire for lower taxes, a Trump presidency could lead to higher government bond issuance resulting in higher funding costs which may reignite debt sustainability concerns in both the US and Europe. With spreads at lows and with dispersion in most industrial sectors subdued, risk premiums in credit could also increase. While slightly stronger growth in the US and a weaker euro may counteract some of the widening pressure, export-oriented sectors and higher-beta segments would likely underperform the most on increased policy uncertainty and prospects of renewed trade tensions. M&A-related uncertainty may also increase as regulatory hurdles lessen for large business combinations.
The outlook for the euro should be dominated by sentiment toward the US dollar. Where the election plays into this, is what the new administration could mean for the path of interest rates, fiscal policy, and the growth outlook more broadly. On balance, notwithstanding the potential for volatility in the short term, the longer-term outlook for the USD is one where its period of dominance is likely coming to an end.
If the election delivers a Harris-led government with a split Congress, we expect this to lend further support to the EURUSD pairing, continuing the upward trend that has coincided with her taking a lead in the polls. This is likely to be due to a more predictable policy path (especially on foreign policy and trade) and less threat of a reversal of the currently expected path of interest rate cuts.
A red sweep scenario would likely prove to be positive for the USD at a least initially, as geopolitical concerns and the threat of trade tariffs lead investors to seek shelter in defensive currencies. Furthermore, the potential for stickier inflation and higher Fed rates should also support the dollar. However, USD strength may not last over the medium term if concerns around a lack of willingness to tackle the US’s sizable budget deficit start to affect the stability of the US Treasury market.
Vice President Harris’s entrance into the presidential race has tightened what was already going be a closely fought election. The closing weeks of the campaign could trigger short-term volatility, and investors should be positioned to manage these risks accordingly. Nevertheless, through the short-term election noise, it is important to remain focused on what the election means for the key factors that will affect investment portfolios: interest rates, growth, regulation, and fiscal policy.
Historically, stocks rise both before and after US elections, but hedging strategies can help investors manage potential downside risks that could materialize if markets fear changes to trade, foreign, or tax policy. We also think that gold can act as an effective hedge against a potential increase in fears about geopolitical polarization, inflation, or deficits. As ever, it is important that any investments should be made as part of a portfolio that is diversified across a range of asset classes and geographies. Historically, a diversified portfolio has proven the most effective way for investors to navigate the uncertainties that political events can, and often do, present. Read more.
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