The latest Fed minutes revealed an unusually high level of Fed policy uncertainty, which can be attributed to a number of reasons, one of which could be the presidential election. The level of economic policy uncertainty this year is much higher than it has been in recent history, and while it’s anyone’s guess who will come out the victor (although that may become clearer after the primaries are over), interestingly enough, close elections lead to only a slightly higher level of policy uncertainty.
Presidential elections cause policy uncertainty to rise
In a report dated March 7, Goldman Sachs analyst Jan Hatzius, Alec Phillips, Daan Struyven and team answered a series of questions focusing on economic policy uncertainty. Their research is certainly fitting in light of economist David Rosenberg’s recent note highlighting that the recent Fed minutes included 24 mentions of the word “uncertain” or its derivatives.
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They have found that presidential elections tend to cause a “modestly” heightened level of policy uncertainty, basing this finding on the Economic Policy Uncertainty Index, which they said also indicates that uncertainty also tends to rise around major economic events like the recent U.S. fiscal declines (another factor we’re seeing right now). As shown by the following graph, however, the Uncertainty Index has a long way to go before it will reach its recent peak in 2011.
In terms of how presidential elections impact policy uncertainty, the Goldman team found that the index’s median level is high at the beginning of an election year, falls over the summer and then climbs again before the November election. They also looked at this trend using the unemployment rate as a control for the economy’s effect on uncertainty and found the results to be similar.
Election uncertainty adds to policy uncertainty but only slightly
The Goldman team found very weak evidence that suggests that a greater level of uncertainty about a presidential election’s outcome might heighten economic policy uncertainty a bit further, but they emphasize that this evidence is weak at best. To come up with this, they looked at the difference in the implied probability of an election’s outcome to measure the perception of election outcome uncertainty.
They added that when third-party candidates figure prominently in an election, uncertainty looks elevated.
This time though, they think controversial Republican frontrunner Donald Trump might impact uncertainty in an unusual way, particularly after former New York Mayor Michael Bloomberg said this week that he will not run as a third-party candidate.
“Donald Trump’s campaign for the Republican nomination involves some of the same characteristics of a third-party candidacy, particularly the potential to upend traditional patterns of support for the two major political parties and potential post-election policy outcomes that are harder than usual to predict,” the Goldman team wrote.
Because of the unusual impact from Trump’s campaign, they think uncertainty could remain heightened longer than usual.
What greater policy uncertainty means for the economy
The Goldman team also said that their research suggests that greater uncertainty can lead employers to reduce their hiring plans and investors to cut back on their investments. The developers of the Economic Policy Uncertainty Index found that for every 10-point “shock” to their index, which the Goldman team said is about the amount of increase in uncertainty that happens between September and November during presidential election years, cuts hiring by approximately 60,000 jobs, all else equal. Further, the Goldman team said their past research suggests about an 0.3 percentage point decline in capital goods orders for every 10-point increase in that index.
They also said that it can cause weaker sentiment among both businesses and consumers—something we’ve already been seeing lately even though the data suggestions the average U.S. consumer is doing just fine. They cited data from a number of business surveys, including the ones from the Philadelphia Fed, the Chicago Fed, and the ISM surveys, which demonstrated that sentiment seems greatly impacted by greater uncertainty.
However, they temper this by saying that even if policy uncertainty keeps rising in a fashion similar to how it has with other close elections, they think the impact on the broader economy will be “modest.”
JPMorgan adds in a morning commentary:
Tuesday races – Trump recaptures momentum; Sanders scores big upset in Michigan. The narrative of the race overall didn’t change Tues w/the Nov general still shaping up to be a contest between Clinton and Trump. However, there were some interesting winkles. On the GOP side Trump recaptured his frontrunner momentum status after a shaky weekend by winning Hawaii, Mississippi, and Michigan (Michigan was the most important state and Trump won convincingly w/37% vs. 25% for #2 Cruz). Cruz scored a single victory in Idaho, cementing his status as the most viable “anti-Trump” candidate (the Trump/Cruz delegate difference stayed about even w/Trump up about ~100 vs. Cruz, 446 vs. 347). Rubio and Kasich both did relatively poorly (Rubio continues to fade; Kasich did OK in Michigan w/a solid #3 at 24% vs. 25% for #2 Cruz but his path to the nomination looks very, very narrow). On the Democratic side, Sanders scored a big upset in Michigan w/50% of the vote (vs. 48% for Clinton). Clinton was expected to win by at least high-single digits and the loss is a notable black eye for his campaign. She still has a very large (most likely insurmountable) delegate lead and will very probably be the nominee but losing Michigan dents her momentum (she did win overwhelming in Mississippi w/83% of the vote). For stocks, the Tues results are neutral-to-negative. US equities still would prefer someone other than Trump or Cruz but have grown resigned to one of them being the GOP nominee. A Clinton presidency (assuming the GOP retains control of Congress) is acceptable (from the perspective of stocks) but her inability to convincingly and quickly defeat Sanders raises doubts about her general election viability (esp. against Trump who is posting impressive turnout figures and demonstrating an ability to turn solidly blue states purple or outright red). The next events to watch will be the Thurs night GOP debate and the Mar 15 contests (Florida primaries, Illinois primaries, Missouri primaries, North Carolina primaries, Ohio primaries).