Stocks are up hugely today, and that makes a certain amount of sense: As the election-results picture has become more clear, investors see they are likely (but not certain) to get a Democratic president and a Republican-controlled Senate, which is favorable to them in a lot of ways.
Trump leaving office should mean an easing of international trade tensions that have harmed manufacturers and other corporations that rely on trade with China. It should also mean less policy uncertainty — no need to watch the president’s Twitter feed for clues about whims that could change the fortunes of businesses. But continued Republican control in the Senate means there aren’t likely to be the significant increases in corporate or capital-gains taxes that Joe Biden hoped to implement. The Senate may also act as a check on Biden’s appointments: Needing to get confirmation from an opposition-controlled Senate, Biden is unlikely to pick a progressive favorite like Elizabeth Warren for Treasury Secretary and is more likely to renominate Jerome Powell to run the Federal Reserve. Investors who wanted Trump to go but wanted some of his policies to stay will have their cake and eat it, too.
That said, the bond market is sending a different signal about a different part of the economy. Yields on ten-year Treasury bonds spiked as the earliest returns came in, when there were higher odds of a Democratic sweep, and then sank as Biden tanked in Florida and a contested election outcome became more likely. The prospect of all-Democratic control had bond investors expecting a huge surge of government borrowing to finance another round of economic stimulus and coronavirus relief. Now, any subsequent fiscal package is likely to be significantly smaller, meaning less borrowing and less upward pressure on interest rates. Less fiscal stimulus will also mean more continued reliance on the Federal Reserve to boost output through monetary policy, which will tend to mean lower interest rates for longer, and you’re seeing that now in lower yields on long-term bonds.
Overall, the stock and bond markets are responding to the prospect that the government will do less with regard to the economy over the next two years than might have been expected on Monday. What does that mean for ordinary Americans? It’s a loss for people who are still out of work due to the coronavirus pandemic, and it’s a loss for people who rely on services from state and local governments facing significant budget gaps, which won’t get the volume of federal relief they were hoping for. That said, I think a lot of people have mental models that this will lead to a repeat of 2010 and 2011, when federal stimulus had proved insufficient and federal austerity — which led to state and local austerity — prolonged the slow and painful recovery from the great recession. I don’t think the picture is quite that bad.
The eventual defeat of the pandemic that is likely to come in 2021 will be a significant economic stimulus in its own right. Household and bank finances are healthier on average than they were in the last recession and so do not require as much fiscal support. State and local budget gaps, while large, are not as large as was feared in the spring, because the economic recovery has proceeded faster than expected to date and the nature of the economic crash had less impact on state and local tax revenues than might have been expected. There was no home-price crash to impair the property-tax base, and consumers’ shift away from buying services and toward buying goods has helped protect the sales-tax base. And you shouldn’t assume zero fiscal stimulus: Senate Majority Leader Mitch McConnell is already talking about getting to work on the next relief package, which is sure to be smaller than Democrats had hoped but will be better than nothing. McConnell is open to including state and local government aid in this package. And the Federal Reserve, while it might prefer that Congress take the lead, also has tools to continue to support economic growth and recovery.
All of which is to say the bull market isn’t just about investors expecting their taxes to stay low. There are good reasons to expect the economy to continue recovering robustly into 2021 under divided government in a way that will benefit workers and consumers as well as investors, even if the process won’t be as clean or robust — or tuned to your political liking — as you’d expected.