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Our Global Head of Fixed Income and Thematic Research outlines the potential impact the upcoming U.S. elections could have on increasing treasury yields, US-China policy and Japan\\u2019s current trajectory.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Thematic Research. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about overseas investors' view on the US election.

 It's Wednesday, Mar 20th at 10:30 am in New York.

 I was in Japan last week. And as has been the case with other clients outside the US, the upcoming American elections were a key concern. To that end, we\\u2019re sharing the three most frequently asked questions, as well as our answers, about the impact of the U.S. election on markets coming from clients outside the US.

First, clients are curious what the election could mean for what\\u2019s recently been a very rosy outlook for Japan. The central bank is taking steps toward normalizing monetary policy which, combined with corporate reforms, is driving renewed investment. And it doesn\\u2019t hurt that multinationals are finding it more challenging to do new business in China due to U.S. policy restrictions. In our view, regardless of the election outcome, these positive secular trends will continue. While its true that Republicans are voicing greater interest in tariffs on US friend and foe alike, in our view there are other geographies more likely to bear the impact of stricter trade policy from the US \\u2013 such as Europe, Mexico, and China; areas where there\\u2019s clearer overlap between US trade interests and the geopolitical preferences of the Republican party.

Second, clients wanted to know what the election would mean for US-China policy. The first thing to understand is that both parties are interested in policies that build barriers protecting technologies critical to US economic and national security. For Democrats, this has meant a focus on extending non-tariff barriers such as export and investment restrictions; many of which end up affecting the trade relationship between the US and China, and over time have resulted in US direct investment tilting away from China and toward the rest of the world.  Republicans support these policies too. But key party leaders, including former President and current candidate Trump, also want to use tariffs as a tool to negotiate better trade agreements; and, potentially as a fall back, to harmonize tariff levels between countries. So, the election is unlikely to yield an outcome that eases trade tension between the US and China. But an outcome where Republicans win could create more volatility for global trade flows and corporate confidence, creating more economic uncertainty in the near term. 

Third and finally, clients wanted to know if there were any election outcomes that would reliably change the trajectory of US growth, inflation, and accordingly the trajectory for treasury yields. In particular there was interest in outcomes that could cause yields to move higher. Our take here is that there\\u2019s been no solidly reliable outcome that points in that direction -- at least not yet. While it's likely that a potential Trump presidency would favor tax cuts and tariffs, it\\u2019s not clear that either of these definitively lead to inflation. Cutting taxes for companies with healthy balance sheets doesn\\u2019t necessarily yield more investment. Tariffs increase the cost of the thing being tariffed, but that could lead to prices of other goods in the economy suffering from weaker demand. Relatedly, the idea that a more dovish Fed could enable inflation is not a foregone conclusion because \\u2013 as we\\u2019ve discussed on prior episodes \\u2013 the President's ability to influence monetary policy is more limited than you might think.

Still, because of the pileup of these factors, it wouldn\\u2019t be surprising to see rates rise at some point this year on election risk perceptions. But it's not clear this would be a sustained move, and so it's not causing us yet to recommend clients\\u2019 position for it. For clients looking for more reliable market moves from the election, we\\u2019re still focused on key sectoral impacts: sectors like industrials and telecom which could benefit from tax cuts in a Republican win scenario; and sectors like clean tech which benefit in a Democratic win scenario, on greater certainty for the spend of energy transition money in the IRA.  

Of course, as markets change and price in different outcomes, interesting macro markets opportunities will emerge -- and we\\u2019ll be here to tell you all about it.

Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts, or wherever you listen, and leave us a review. We\\u2019d love to hear from you.