A ‘blue wave’ in U.S. elections could bring forward Fed rate hikes, says Morgan Stanley

A Democratic sweep in the coming U.S. elections will likely unleash more fiscal stimulus, but it could also cause the Federal Reserve to hike interest rates earlier than expected, said a Morgan Stanley portfolio manager.

The first rate hike by the Fed could be brought forward from around 2024-2025 to 2023-2024 — depending on how other policies, such as taxation, turn out in the event of a “blue wave,” said Jim Caron, a senior member of Morgan Stanley Investment Management’s global fixed income team.

A “blue wave” refers to an election outcome where Joe Biden defeats Donald Trump in the presidential race, and Democrats win a majority in both chambers of Congress.   

Caron told CNBC’s “Squawk Box Asia” on Wednesday that the U.S. economy, under pressure from the coronavirus pandemic this year, was already expected to rebound in 2021. Additional stimulus that’s likely to come with a “blue wave” would boost that growth potential further, he added.

“That means the growth impact could go into not just 2021, but also 2022,” he said.

“The effect that this has though — that we need to be wary of — is that this could bring the first rate hike, nobody wants to talk about rate hikes right now, but this could bring the first rate hike by the Fed in from 2024 to 2025 to maybe 2023 to 2024,” he explained.

The Fed has maintained its policy rate near zero since March and indicated that rates could stay at that level through 2023. That has kept Treasury yields low, even though they rose on Tuesday on a potential stimulus package ahead of the November elections.

But Caron warned that a Democratic win in the November elections might not be all good for the U.S. economy. He said there could be “more questions than answers” on issues such as the Democrats’ tax policy and their approach toward regulation, which could create uncertainties.

Many investors fear that a Biden win could result in higher taxes and tighter regulations — which could lead to lower corporate profits and less economic growth.

“I think the markets are being a little bit complacent about, just thinking that: ‘Well on Nov. 3, the day of the election, we’re going to get all the answers and everything’s going to be great going forward’,” said Caron.

“I actually think there’s going to be more questions than answers after the election than there is right now.”