Political Economy Cheet Sheet: Three debates and their market implications – Morgan Stanley

For investors, US fiscal policy, tax increases and US-China relations are three key items to watch as we head toward fall. Economists at Morgan Stanley outline potential outcomes.

Fiscal policy in the US

“Expect progress to be made toward a fiscal deal that will approach $4T of new spending over 10 years. We think this will be approved in the fourth quarter, but do not expect that progress to come without some drama. Roadblocks could certainly keep a lid on investors' deficit growth expectations, and therefore Treasury yields for a time, but we expect Democrats ultimately find a way through. This, together with the approaching Fed taper talk and the expectation that the recent COVID-19 wave should mitigate this fall, should open the door to higher Treasury yields through year-end.”

Tax policy in the US

“Expect this fiscal deal will come with tax increases, but that those changes will fall short of the request by the White House. Smaller tax increases may mean deficit expansion as part of the fiscal deal, but this is likely a more palatable option than letting the fiscal deal fail. If we're right, then the good news for markets is that we calculate these increases as having a modest impact on net income for S&P 500 companies.”

Relations between the US and China

“Expect things to get noisy. We expect more steps on the path toward a multipolar world – that companies should continue to prepare for the U.S. and China economies to have even more rules of engagement, increasing transaction costs for doing business with one another. That could take the form of non-tariff barriers like rules regulating customer data collection.”