Welcome to Thoughts on the Market.
I'm Michael Zizis, Global Head of Fixed Income Research and Public Policy Strategy.
And I'm Ariana Salvatore, U.S.
Public Policy Strategist.
Today we'll be talking about the outlook for US public policy and its interaction with markets into 2026.
It's Wednesday, December 17th at 1030 a.m. in New York.
So, Ariana, we published our year ahead outlook last month.
And since then you've been out there talking to clients about US public policy, its interaction with markets and how that plays into 2026.
What sorts of topics are on investors' minds around this theme?
So the first thing I'd say is clients are definitely interested in our more bullish outlook, in particular for the US equity market.
And normally we would start these conversations by talking through the policy variables, right?
Immigration, deregulation, fiscal and trade policy.
But I think now we're actually post peak uncertainty for those variables.
And we're talking through how the policy choices that have been made interact with the outlook.
So, in particular for the equity market, we do think that some of the upside actually is pretty isolated from the fact that we're post-peak uncertainty on tariffs, for example.
Consumer discretionary.
The double upgrade that our strategists made in the outlook has very little to do with the policy backdrop and more to do with fundamentals and things like AI and the dollar tailwind and all those factors.
So I think that that's kind of a key difference, I would say.
It's more about the implementation of these policy decisions rather than which direction is the policy going to go in.
Picking up on that point about policy uncertainty, when we were having this conversation a year ago, right after the election, looking into 2025, the key policy variables that we were going to care about trade, fiscal policy, regulation there was a really wide range of plausible outcomes there.
With tariffs, for example, you could make a credible argument that they weren't going to increase at all, but you could also make a credible argument that the average effective tariff rate was going to go up to 50 or 60.
While the tariff story certainly isn't over, going into 2026, it certainly feels like we've landed in a place that's more range-bound.
It's an average effective tariff rate that's four to five times higher than where we started the year, but not nearly as high as some of the projections would have.
There's still some negotiation that's going on between the US and China and ways in which that could temporarily escalate, and with some other geographies as well.
But we think the equilibrium rate is roughly around 20%. where we're at right now.
Fiscal policy is another area where the projections were that we were going to have anything from a very substantial deficit, expansion tax cuts that wouldn't be offset in any meaningful way by spending cuts, to a fiscal contraction which was going to be more focused on heavier spending cuts that would have more than offset any tax cuts.
We kind of landed somewhere in between.
It seems like there's some modest stimulus in the pipe for next year.
But again, that is baked.
We don't expect Congress to do much more there.
And in terms of regulation?
Listen, this is a little bit more difficult, but regulatory policy tends to move slowly.
It's a bureaucratic process.
We thought that some of it would start last year, but it would be in process and potentially hit next year and the year after.
And that's kind of where we are.
So we more or less know how these variables have become something closer to constants.
And to your point, Arianna, now it's about observing how economic actors, companies, consumers react to those policy choices and what that means for the economy next year.
All that said, there's always the possibility that we could be wrong.
Going back to tariffs for a minute.
What are you looking at that could change or influence trade policy in a way that investors either might not expect or just have to account for in a new way?
So I would say the clearest catalyst is the impending decision from the Supreme Court on the legality of the IEPA tariffs.
I think on that front, there are really two things to watch.
The first is what President Trump does in response.
Right now there's an expectation that he will just replace the tariffs with other existing authorities, which I think probably should still be our base case.
There's obviously a growing possibility, we think, that he actually takes a lighter touch on tariffs, given the concerns around affordability.
And then the second thing I would say is on the refunds piece.
So if the Supreme Court does in fact say that the Treasury has to pay back the tariff revenue that it's collected?
We've investigated some different scenarios, what that could look like.
In short, we think it's going to be dragged out over a long time period, probably six months at a minimum.
And a lot of this will come down to the implementation and what specifically Treasury and CBP, its Customs and Border Protection sets up to get that money back out to companies.
The second catalyst on the trade front is really the USMCA review.
So this is an important topic because it matters a lot for the nearshoring narrative, for the trade relationship that the US has with Mexico and Canada.
And there are a number of sectors that come into scope.
Obviously, autos is the clearest impact.
So that's something that's going to happen by the middle of next year.
But early in January the USTR has to give his evaluation of the effectiveness of the USMCA to Congress.
I think at that point, we're going to start to see headlines.
We're going to start to see lawmakers engage more publicly with this topic.
And again, a lot at stake in terms of North American supply chains.
So that's going to be a really interesting development to keep an eye on next year, too.
So what about things that Congress might do?
Recently the president and Democrats have been talking about the concept of affordability in the wake of some of the off-cycle elections where that appeared to influence voter behavior and give Democrats an advantage.
So are there policies, any legislative policies in particular, that might come to the forefront, that might impact how consumers behave?
So a really important starting point here is just on the process itself, right?
So, as we've said, one of the more reliable historical priors is that it's difficult to legislate during election years.
That's a function of the fact that lawmakers just aren't in D.C. as often.
You also have limited availabilities in terms of procedure itself, because Republicans would have to probably do another reconciliation bill unless you get some bipartisan support.
But, hitting on this topic of affordability, there are really a few different things on the table right now.
Obviously, the president has spoken about these tariff dividend checks, the $2,000.
They've spoken about making changes on housing policy, so housing deregulation.
And then the third is on these expanded ACA subsidies.
Those are obviously the crux of the government shutdown debate.
And for a variety of reasons.
I think each of these are really challenging to see moving over the finish line in the coming months.
We think that you would need to see some sort of exogenous economic downturn, which is not currently in our economist baseline forecast, to really get that kind of more reactive fiscal policy.
And because of those procedural constraints, I would just go back to the point we were saying earlier around tariff policy and maybe the Supreme Court decision giving Trump this opportunity to pull back a little bit.
It's really the easiest and most available policy lever he has to address affordability.
And to that point, the administration has already taken steps in this direction.
They provided a number of exemptions on agricultural products and said they weren't going to move forward with the Section 232 tariffs on semiconductors in the very near term.
So we're already seeing directionally, I would say, movement in this area.
Yeah, and I think we should also keep our eye on potential legislation around energy exploration.
This is something that in the past has had bipartisan support, loosening up regulations around that.
And it's something that also ties into the theme of developing AI as a national imperative.
That being said, it's not in our base case, because Democrats and Republicans might agree on kind of the high points of loosening up regulations for energy exploration, but there's a lot of disagreement on the details below the surface.
But there's also the midterm elections next year.
So how do you think investors should be thinking about that as a major catalyst for policy change?
Or is it more of the same?
It's an interesting story that we should track, but ultimately not that consequential.
So obviously we're still a year out.
A lot can change.
But obviously we're keeping an eye on polling and that sort of data that's coming in daily at this point.
The historical precedent will tell you that the president's party almost always loses seats in a midterm election.
And in the House with a three-seat majority for Republicans, the bar is actually pretty low for Democrats to shift control back.
Thank you so much for having me.
In the meantime, I think you could also expect to see more kind of political fights around things like appropriations funding, the government, the debt ceiling.
That's typical of divided governments, unless you have some area of bipartisan support.
Like I said, maybe we see something on health care, crypto policy, AI policy, industrial policy is becoming more of the mainstream in both parties.
So potentially some action there.
But I think that's probably the limit of the most consequential policy items we should be looking out for.
Right.
So the way I've been thinking about it is no clear new policies that someone has to account for coming out of the midterms.
However, we definitely have to pay attention.
There could be some soft signals there about political preferences and resulting policy preferences that might become live a couple of years down the line, after we get into the 2028 general elections and the new power configuration that could result from that.
So interesting, impactful, not clear that there'll be fundamental catalysts.
And probably along the way.
We should pay attention because markets will discount all sorts of potential outcomes.
And it could get the wrong way on interpreting midterm outcomes, which could present opportunities.
So we'll certainly be tracking that throughout 2026.
Yeah, and if you think about the policy items that President Trump has leaned on most heavily this year and that have mattered for markets, there are things in the executive branch right.
So tariff policy obviously does not depend on Congress.
Deregulation helps if you have fundamental backing from Congress, but can occur through the executive agencies.
So to your point, less to watch out for in terms of how it will shift Trump's behavior.
Well, Ariana, thanks for taking the time to talk.
Always great speaking with you, Michael.
And to our audience, thanks for listening.
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