If Trump loses but won’t concede, how will the markets react?

We will see.
We will see.
Image: Reuters/Tom Brenner
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The US executive branch has seen a lot in the past couple of centuries: assassinations, resignations, contested elections. But what would happen if the president was voted out of office and refused to leave?

That’s what traders and investors asked themselves this week, after US president Donald Trump refused to commit to a peaceful transfer of power if he loses in November. He claims that mail-in voting, which is likely to surge because of the pandemic, is subject to fraud—even as the FBI director said this week that there isn’t any evidence of a concerted effort to rig the election.

US Senate majority leader Mitch McConnell told Fox News there will be “an orderly transfer of power,” and the Senate passed a resolution by unanimous consent to show support for a peaceful transition.

Despite the reassurance, the controversy has caused a tremor in global finance, rippling through foreign-exchange markets and some measures of risk, according to Alberto Gallo, head of macro strategies at hedge fund Algebris Investments. “Markets have definitely moved to price in a higher probability of a contested vote since the last weekend,” he said.

That’s on top of the uncertainty over whether lawmakers will agree on another aid package to help the economy through the pandemic, a concern that has weighed on stocks in recent weeks after some initial measures expired.

The spectrum of predicted election outcomes range from the bizarre, with Trump somehow barricading himself in the Oval Office, to the more likely possibility of a contested result that ends up in court for weeks, to the hope for a clear outcome and smooth succession.

Some on Wall Street worry that the worst-case scenario, with Trump refusing to recognize the will of the voters, could undermine global investor confidence in the country’s rule of law—the heretofore dependable underpinning of the highly functional US markets—and spark a constitutional crisis.

There’s really no precedent for that situation (in the US, at least), but the world arguably got a tiny taste of the risks in August 2011, when, following a period of brinkmanship in Congress over whether to raise the debt ceiling or send the country into default, the US lost its top AAA credit rating from Standard & Poor’s. The credit-rating company said the downgrade to AA+ reflected its view that the US’s “policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges.”

The stock market tanked and volatility shot through the roof, right on cue. But somewhat awkwardly, US Treasury securities, the very asset that had been downgraded, increased in value (while interest rates on Treasury bonds, which move inversely to prices, plunged). In essence, the US lost its AAA rating and it became cheaper for the country to borrow money.

At the time, some economists and investors argued that the scramble for American debt showed that S&P’s analysis was flawed. Others suggested that traders had merely sought out the most liquid thing they could find. (Say what you will about America, it’s got a lot of debt and it’s easy to trade.)

One could say the episode showed that doubts were growing, at least among some experts, as to the safety and soundness of US institutions. Nonetheless, US Treasuries remain the bedrock of the global financial system, the “risk-free” instrument that underpins interest rates and asset prices around the world.

If history is any guide, investors could make a dash for US debt in the event that Trump does the unthinkable.

Some are still sanguine

Not everyone is panicking about the hypothetical worst-case scenario—the one where Trump, iPhone in hand and Twitter app at the ready, barricades the doors to the White House’s West Wing.

“The US system has many checks and balances,” says economist Campbell Harvey.  “Even if Trump stays, there are very few things he can do.”

“I do believe there is a messy scenario where nothing happens in government due to the chaos,” adds Harvey, the Duke University professor who pioneered the yield-curve as an economic prediction tool. “However, markets always look ahead.”

Past turmoil in executive succession didn’t permanently derail financial markets, Harvey notes. When John F. Kennedy was assassinated in 1963, investors were arguably more preoccupied by the risk of a nuclear war between the US and the Soviet Union. President Richard Nixon’s resignation in 1974, and the assassination attempt against president Ronald Reagan in 1981, didn’t cause investors to lose faith in the US. Reagan “managed it well by telling jokes all the way into surgery,” Harvey says. “Nixon’s resignation, like Reagan being shot, was not associated with any systemic risk.”

Harvey points out that there are plenty of examples of parliamentary systems in which leaders have lost their majority, causing uncertainty over who will be in charge. After a period of negotiation, these countries typically piece together a coalition to continue ruling. Belgium recently went without a government for nearly a year. During that time, Belgian 10-year bond yields increased only slightly relative to Germany’s debt. After the government was sorted out, the spread went back to its normal range, and Moody’s Investors Service went on to describe Belgium as having “very high institutional strength.”

There is a real chance that the US government will be in limbo after Nov. 3, as there could be a delay in counting mail-in ballots. “Lawyers on both sides are gearing up,” Harvey said. “It would not be surprising for the election to be determined in the courts.”

That’s what happened in November 2000, in the race between Democratic candidate Al Gore and Republican George W. Bush. The contest came down to the results in Florida, where both campaigns sent teams of lawyers, and suits were filed over the validity of recounts. The dispute went to the US Supreme Court, whose decision ultimately led to a Bush victory. Gore conceded the race in December, more than a month after Election Day.

How did traders take the news? Treasury bonds, as usual during times of uncertainty, rallied, while the S&P 500 Index of large US companies declined. The election uncertainty didn’t create a systemic risk for the US or undermine faith in the US dollar as a store of value.

When analyzing politics, investors are more likely to consider things like an increases in corporate taxes, or the potential for large businesses to be broken up over anti-trust concerns.

To wreak havoc on the markets, “[p]olitical risk needs to be linked very specifically to damage to either the economy or the value of companies,” Harvey says. “It is not clear that is the case with some sort of limbo after the election.”

The question this time around, presuming there is some sort of limbo period, is how destabilizing it will get.