Will U.S. Politics Derail Markets in the Fall?

As we near the end of summer, we see quite a bit of volatility continuing through the markets. We have also seen a lot of electoral risks starting to filter through the markets in the U.S. Policy and budget debates have begun in Washington D.C., so we are looking at those conversations to examine what this commotion could mean for the markets as we head into the end of the year.

Indictments, Impeachments and Investigations

These "three I's" sum up the focus of U.S. politics right now. The velocity and the force of this influence on Washington D.C. was greater in August than we initially anticipated.

Indictments:

While subject to change, former President Donald Trump now faces four criminal trials next year. Totaling 91 felonies in four jurisdictions, we have better clarity on those dates:

• March 4th, 2024: The two big cases; The 2020 election interference case and the January 6th case in Washington DC. It's also the day before Super Tuesday.
• To be determined: The Georgia election interference RICO case in Georgia. Of note that Georgia case is state crimes which are ineligible for a presidential pardon.
• March 25th, 2024: The so-called "Hush Money Case" in New York.
• May 20th, 2024: The so-called "Documents Case" in Florida.

Impeachment:

The House Republicans launched an impeachment inquiry into Democratic President Joe Biden. Now the issue with that is going to be getting the votes. To do that, it takes a simple majority in the House for an impeachment charge. Also, it's a little unclear what those charges would be. Regardless, getting a two-thirds vote in a Senate trial, there is, in our estimation, a 0% probability of that.

Investigations:

Not originally on our radar screen was declining health of 81-year-old Senate Republican Leader Mitch McConnell. There are two policy and political implications if McConnell should leave the Senate before his term expires on January 3rd, 2027, on both a foreign policy front, but also just pure domestic policy.

• Support for Ukraine: McConnell has been one of the staunchest, if not the most successful champions of Ukraine in the U.S. Senate and NATO. Without McConnell, getting additional Ukraine supplemental aid could be a real challenge.
• Democrat nomination: The Governor of Kentucky, Andy Beshear, is a Democrat running for re-election this November 2023. If McConnell left the Senate, Beshear could nominate a Democrat to replace him. The Kentucky legislature has passed a law in 2021 that basically ties Beshear's hands and that he would have to nominate a Republican if McConnell's seat became vacant, but there are questions as to whether that law is Constitutional.

The market effect

The big news has been a continued upward shift in rates, although the reason for it has been several fold. One is the big repricing in Fed expectations. There's the trough rate, the rate at which the Fed has predicted to stop cutting rates down the line, actually increased over time. So, what we've seen over the last month or so is a big upward shift in the trough rate from about 3.3% to 3.8%. The market is effectively staying higher for longer.

Alongside that we've seen cuts for 2024 getting priced out. The market is pricing in more odds of this soft landing because at the same time the data has been OK. The market has largely ignored the Fitch downgrade of the U.S. debt rating, but it does raise the question of where are things headed? You've got real rates quite a bit higher. You've got expectations that the Fed will be quite a bit more restrictive for longer.

So, what is the inflection point for the cycle? At what point do rates get too high? Many analysts downplay how thin August markets really get. There can be a lot of volatility on second, third, and fourth tier data releases when there's not a lot of people around.

What we do observe is concern about what happens in the next three to six months, and less so what happens in the next 12 to 18 months. It's that uncertainty over the timing of the slowdown that is often the focus. We're going into the fall with much tighter monetary policy to some extent, and much tighter fiscal policy for markets. It is concerning because the market appears to be pricing in nothing but good news, but there's reason to believe a number of risks could be coming down the pipeline.