Growing signals suggest the Republicans could clinch a victory in today’s elections, a scenario generally regarded as optimal for investors. A Republican Sweep would mean lower taxes, deregulation, and increased government spending. However, the gap between the Republicans and Democrats remains too narrow to confidently predict a winner, raising the likelihood of a contentious, potentially escalating dispute over the results.
There is even a possibility that the election could precipitate a recession. Typically, recessions feel like the economy tumbling off a cliff, often triggered by an external shock, such as the 9/11 attacks or the Lehman collapse. Post-election, there are at least three possible external shocks on the horizon.
Rising interest rates
Should there be a Republican Sweep, it’s likely that U.S. interest rates will rise. If this increase is limited to around 20 basis points and reflects a reaction to stronger nominal growth under Republican policies, the impact may be modest. However, if rates soar more sharply due to concerns over the deficit and mounting national debt, this rise could ripple through the U.S. economy.
Currently, 17 percent of the U.S. budget is spent on interest payments for national debt—more than 1 trillion dollar per year, outpacing even defence spending. As this figure climbs, fiscal room for manoeuvre shrinks further. In fact, U.S. interest rates might even be somewhat low at present.
Despite the Fed’s many rate hikes, U.S. economic growth appears to be accelerating rather than slowing. It’s likely that both real interest rates and inflation expectations need to rise further to reach a neutral level.
Sharp rise in import tariffs
A substantial increase in import tariffs would likely trigger a recession. Tariffs are effectively an additional tax on U.S. consumers, and companies reliant on Chinese imports would be hit hard.
Take Walmart, the largest employer in the U.S., which could well abandon its “everyday low prices” slogan since 80 percent of its stock comes from China. There is talk of a 60 percent tariff on Chinese goods, though it’s unlikely to be enacted.
Scott Bessent, a leading candidate for Treasury Secretary under Trump and former CIO of Soros Fund Management, views the 60 percent tariff as leverage to bring China to the negotiating table. This highlights a key difference between Democrats and Republicans: since the Anchorage summit, Democrats have shown little interest in engaging with China, while Republicans under Trump are far more inclined to strike a deal.
The risk, however, is that Trump’s unpredictability could lead to a prolonged standoff, which could hurt the U.S. economy. History, particularly the 1930s, shows that such protectionism doesn’t drive inflation but does risk a recession.
Balancing the budget
The biggest recession risk arises if Kamala Harris wins the presidency but Republicans gain control of Congress. In such scenarios, Republicans tend to shift focus towards achieving a balanced budget.
This was the case in the 1990s under President Clinton, when Republican House Speaker Newt Gingrich froze U.S. government spending. Similarly, after the Great Financial Crisis, with Obama as president, Republican John Boehner pushed for spending restraints, backed by the Tea Party. Under Clinton, this resulted in a budget surplus, a rare feat in U.S. history. Under Obama, it led to slower growth in the “new normal.”
This time, however, the U.S. budget deficit has ballooned to 7 percent of GDP. Pushing to balance the budget quickly could very well tip the economy into a recession.
Conclusion
Right after the election, the Federal Open Market Committee will meet to decide on interest rates. Following last Friday’s jobs report, there’s little debate that a quarter-point rate cut is likely, despite disruptions from hurricanes and strikes.
It would be unusual for the Federal Reserve, which lowered rates by half a point during the campaign, to suddenly halt rate cuts now. Such a move could appear politically motivated. For monetary policy, it’s beneficial if Congress and the presidency are held by opposing parties, as either a Republican or Democratic Sweep would likely drive the deficit higher.
The silver lining in an increased recession risk is that the Federal Reserve still has room to cut rates further. This could prevent a recession altogether or at least soften its impact. Such an aggressive rate cut would undoubtedly stir market sentiment.
Han Dieperink is Chief Investment Officer at Auréus Wealth Management. Previously, he served as Chief Investment Officer at Rabobank and Schretlen & Co.