Just as presidential candidates are on the road engaging in debates and meeting with voters ahead of the 2016 presidential election, I’ve been on the road speaking with Investment Professionals about what the election means for government spending, financial markets and investors.
I recently traveled to Florida to speak with financial advisors, where I shared my view that the 2016 presidential election cycle means the “age of austerity” is ending as Congress approves spending measures in order to woo voters. I explained that this spending may have unintended consequences for the US dollar, and that there are sectors that could benefit from increased government spending.
Congress boosts fiscal spending ahead of the presidential election
During major elections, Congress is known to approve spending measures to curry favor with voters and the upcoming presidential election is no exception.
Late last month, Congress passed a budget deal that will boost domestic and defense spending while extending the debt limit until March of 2017.1 The deal increases discretionary spending by $80 billion over two years, with $50 billion available in fiscal 2016. It also requires the Energy Department to sell crude oil from the Strategic Petroleum Reserve, raising $5.1 billion over 10 years, and for two years the deal lifts the sequester budget caps put in place by the 2011 Budget Control Act.2
Adding to this fiscal stimulus, the House passed a multi-year highway bill in early November that includes more than $300 billion in transportation and infrastructure programs.3
End of the age of austerity may constrain the US dollar
From 2011 until 2014—what I refer to as the age of austerity—government policy detracted from US GDP. The newly passed legislation means government spending is likely to serve as a cushion to GDP through 2017. However, we all know there is no such thing as a free lunch and Washington’s attempt to move away from austerity will have consequences.
One consequence is that the federal budget deficit is forecast to increase in 2016 after having declined for four years. Another consequence, which many investors I speak with are not expecting, is that the strength of the US dollar could slow in the next two years as the trade deficit widens.
In previous years, quantitative easing measures implemented by the Federal Reserve (Fed) helped push down the value of the dollar. As depicted in the “US Exports vs. US Trade Weighted Dollar Index” graph below, that drove demand for US exports, helping to shrink the trade deficit. But that trend has reversed itself. In the past 12 months, the dollar has strengthened considerably, making US exports more expensive for trade partners and widening the US trade deficit.
Source: State Street Global Advisors, Bloomberg, as of 9/30/2015
Market participants seem to be operating under the principal that we will see continued strength in the US dollar as Europe and Asia take a page from the Fed’s playbook, implementing accommodative monetary policies to stimulate growth. However, I believe the impending US budget deficit and widening trade deficit are signaling that the tailwinds that have bolstered the dollar’s strength are easing and evolving headwinds could constrain its ascent.
Government spending could embolden the Federal Reserve
It’s no surprise that the advisors I spoke with in Florida wanted to understand how this presidential election will impact markets and what pockets of opportunities might emerge.
With government spending set to increase for the first time in years, companies like General Electric and UPS that rely on government contracts for a high percent of their sales stand to benefit. The industrial sector could get a boost from the first increase in defense spending since 2010, as could aerospace and defense stocks.
It also seems increasingly possible that the government’s fiscal stimulus could embolden the Fed to move toward a path of interest rate normalization.
Fed Chair Janet Yellen said earlier this month that a December interest rate increase was a “live possibility” if data continued to indicate the US economy was performing well.4 While a December rate hike is not certain, the Fed has been eager for signs of additional fiscal stimulus and may be more likely to embark on a path toward rate normalization knowing the US economy will benefit from government spending that could offset the effects of monetary tightening.
I expect the road to Election Day 2016 will be a long one, with many twists along the way. In my next post, I’ll look at how stock markets tend to behave during presidential election years. From time to time over the next year, I will be blogging about the election and its implications for investors. If you have any election-related questions you’d like me to cover in future posts, please leave a comment below.
1Politico, “Congress passes budget deal,” as of 10/30/2015
2Washington Post, “What’s in the budget deal?,” as of 10/27/2015
3Washington Post, “House Passes $300 Billion Bill to Improve Roads and Bridges,” as of 11/5/2015
4CNBC.com, “Janet Yellen: December rate hike a ‘live possibility’,” as of 11/4/2015