Shock and awe: US politics and policy in 2026

Welcome to Beyond the Benchmark, the EFG podcast with Moz Afzal.

Moz Afzal:

Hi everyone. So today we have a very special guest, Dan Clifton, and very glad to have you on the podcast.

Dan Clifton:

Thank you for having me on. This is really our third appearance together in 2025. We did the January conference, right? We did a mid-year review, so I'm really glad that we can kind of bow tie this year what we learned and look ahead to next year.

Moz Afzal:

Yeah, no, absolutely. So let me first straight to you, Dan, what is going on?

Dan Clifton:

Well, there's a lot going on and our thesis coming into this year was that you have the first president since 1893 to get elected without a second consecutive term, and that's really important because this is a president who was well rested. He believed that he had a mandate to be brought back and he had a staff for four years working on a host of different policy issues on trade and tax and deregulation, and they came out and flooded his own on all of these issues and it created a lot of uncertainty but also produced some good results as well. I think there's been a lot that's been consistent with our initial view. There would be tariffs. Those tariffs came in initially higher than expected, 700 billion. The financial markets and politics did not like that for five days. So we lowered those tariffs, we spread them out.

Congress came in and passed major fiscal policy legislation and the odds of a recession, which spiked on April 2nd, really did begin to come down. And I think those were very important changes for not only 25, but also how 2026 is going to operate. I will say this, this is a critical point is that most of the spinach, meaning the tariffs and the bad economic data have now been built into the system and we've been eating that spinach. You're seeing it in slower employment growth in the us. If you look at employment, most of the declines in US employment have come from small business owners. So it's hard to make the case that this is AI that's probably coming, but that's not where we are. And it feels like some of those small business owners ate the tariffs and ended up reducing employment. It's showing up on their margins.

Now what you see is the Fed responding to that decline in employment and moving away from their concern of inflation over employment, and now they're more concerned about employment over inflation. So three rate cuts from the Federal Reserve into year end, the Federal Reserve ending, quantitative tightening, and actually expanding their balance sheet to make sure that there's enough bank reserves in the system and a real design failure of the Trump administration Congress on the tax bill by delaying when those provisions go into effect, they could have had those provisions come into effect in July, cutting the income tax rate, cutting the corporate tax rate and sterilising those tariffs immediately. But they delayed them out and so the candy is coming and 2026 promises to be a shock and awe year for fiscal and monetary policy. We're going to get 150 billion of incremental consumer aid that comes out in February, March and April of 2026.

That's a half a percent of GDP flowing into consumer bank accounts. And then the way the tax bill was designed is that you have tax cuts for expensing of capital goods, expensing of research and development and for property. So you are going to get a pickup on the non-residential fixed investment side of GDP as well, all as that monetary policy is hitting. And so this is very consistent with history. If you go back over the last 30 years, the first year of a president's term, they get about two and a half percent GDP growth and the second year, the midterm year, they get about 3% growth. So this president trying to prime the pump in year one usually gets that growth in year two. And I think we're on a very, very similar path this time around. It's been clunky, it's been chaotic, but I think that's how you kind of break through the noise of where we are right now.

Moz Afzal:

So on the economic growth front, so actually we actually agree with you in our 2026 outlook we actually had, I'll tell you, quite a positive economic outlook and I think we're very consistent with you in your thinking. So as we get that fiscal stimulus hitting, as you said into Q1, that will start to feed through into I guess earnings and so forth. Now let's talk a little bit about that impact we'll have on the midterms because obviously at the moment domestically Trump is not doing that well and losing popularity is a bit of a freefall at the moment. How will that economic growth help him in the midterms?

Dan Clifton:

So the nature and the rhythm of politics has been for the party in power to lose in midterm elections, there are really only two or three cases where the party in power prevented that from happening. Two of them were like wars just to give you context of what it is. And so you have that natural feeling going on. Trump won what I call a relative presidential election vote for me over her, the meaning vice President Harris. Now he's in absolute mode where voters are looking and sizing him up. This is what happens normally amongst presidents. The economy has always been his greatest strength. So think about that. And we had double digit unemployment and voters still didn't blame him for the economy, but on April 3rd, they started blaming him for tariffs and he's never recovered from that. Okay, so his approval rating has slowly been coming down.

This is important because what we found is that the single most important variable for midterm elections is the president's approval rating, not the economy. Now presumably if the economy is doing well, you're going to have a higher approval rating. So there's some bit of multi linearity there, but my sense here is that when you look at the approval rating of the president, it's roughly consistent with a 25 to 35 seat loss in the House of Representatives and the Democrats only need three seats to lose. I'm not a big fan of polling. Polling has been failing in the us. So what we try and do is look at what are called special elections, special elections. We've had 38 of them at the federal and state level combined since last November. And the Democrats have gained ground relative to last year in 32 of those 38 special elections, and by an average of 11%, that is a very large number.

So you are seeing this broad move to the Democrats like you normally see in a first term president, and that suggests that Democrats have an 85% probability of winning the house and the Republicans are still favoured to win the Senate. I would just say that the odds right now at about 33% are probably a little bit low. That's not the question you asked, so I just gave you this long windup. The question you asked is how is the growth going to help most presidents get higher economic growth in the midterm election year? So I think growth will help narrow some of those losses, but what we see is that Democrats are horrified at what Trump is doing and Republicans are just like, eh, I'm not sure this is what I got into this for, and they're just not energised to vote. One key point though, if you go back to that first question that you asked, we are going to get a lot of fiscal stimulus in 2026 and the Republicans are banking on the idea that that stimulus is going to take that very depressed consumer sentiment we're seeing in the US and begin to lift that up and we'll see if they're successful on that, it's worth monitoring.

Moz Afzal:

Yeah. So one of the, I guess key issues at the moment is Trump seems to be quite successful in international affairs but is losing his mojo on domestic affairs. Do you think there's going to be some sort of pivot from him to get back to the domestic affairs?

Dan Clifton:

Yeah, I think we're starting that right now. Look, the domestic political environment in the US is frustrating and I think he's frustrated by it and look, he thinks that he's making progress on the economy and not getting credit for it. They're like, we elected you for one job and that was to get rid of the inflation that happened in the last administration and be able to get us back to something like 2019.

We may never get that 2019 economy, but it doesn't even look like he's trying to some voters that we see in the focus groups. And I think that's going to force some sort of a pivot from the administration. That does not mean that he's not going to be involved in all these larger issues. He does see them as very much related. If you get resolution in Russia, Ukraine, it takes some of the geopolitical premium out of oil, and oil is important for gasoline prices here in the us. Getting resolution with China could help get the farm economy restarted again, the farm economy is struggling a lot and those soybean purchases are going to help. So it's not either or. But I do think that there has to be a little bit more of a focus on the US because that's what he was elected for and it looks like he's been ignoring it a little bit.

Moz Afzal:

So moving onto his other agenda items. So deregulation was obviously a really key point for him. He's had some success and as a genius act seems to be worrying its way through. But what are the other key things that we need to look for when it comes to deregulation?

Dan Clifton:

So I think 2026 is going to be the year of financial deregulation. What you saw in the last couple of weeks is the finalisation of what's called the supplemental leverage ratio, which is more of an emergency measure. So if you get something like Covid or April 2nd, it works as a stabiliser for the banks to deploy more capital and I think helps in case of an emergency, it's pretty limited. It only impacts some banks, but it's about $13 billion. What you'll see in February is Governor Bowman on the Federal Reserve likely to release a comprehensive financial deregulation plan. That plan will have to go through the Fed, the FDIC and the OCC. So it'll take some time for it to go through and some of the provisions will be controversial, but the basis of what they're trying to do is to start to remove some of the protections that went into effect after the financial crisis that has forced the banks to hold an inordinate amount of excess capital on its balance sheet.

So there's estimates that the big banks hold two to 250 billion of excess capital, and if you start to make changes to the global systematically important bank surcharge, you can actually start to unlock some of that capital and when that capital gets unlocked, then there could be investments in mortgage-backed securities or treasuries that will help to bring down bond yields and mortgage rates overall. So there's a lot of talk here about the affordability agenda. There's not much you can do from a policy perspective and wave the wand and fix housing. You basically got to get rates lower, you got to get demand better, and you got to get more supply of housing and the rates piece is the most important. And they're probably going to do that through financial deregulation, which is fascinating to me. Now that will show up in mid-year, but it's massive.

Moz Afzal:

Yeah, something we've been thinking about quite a lot is that at the moment in that sort of China US AI race, essentially just the two of them, no one else, Europe started to regulate AI before it even started, which meant we got nowhere, but US and China clearly are the leaders to it. China certainly now eyes has got the energy part sewn up, essentially the number of nuclear plants, clean energy in terms of solar and wind, they're far more advanced. Clearly Trump doesn't like solar or wind in terms of energy policy. Has that really come across? Do they really know they're a huge disadvantage relative to China on the energy race?

Dan Clifton:

I do. I do. The one thing I would say about wind and solar, it's less about wind and solar, it's more about the subsidies and what the subsidies are paying for. So those subsidies are paying for Chinese goods and the US is just in this kind of decoupling, we can say deglobalization, decoupling, they just want to reduce their reliance on Chinese goods. And there's a transition period where the US will build its own clean energy sector and that will be less of an issue around solar when you get there overall. But again, that's all part of transition. Small nuclear reactors are six years away, so there clearly is that disadvantage. Where the US has the advantage though is that the US has the chip advantage, something that China is trying to build itself out, and ultimately China's going to get there. They're building their own chip industry, but the US is now saying, okay, they're building their own chip industry.

We got to build our own rare earth industry. And I think that's where the discussion is to give our leadership credit. Both G and Trump are saying, we don't want to have a major disruption, so we don't like you. They pretend like they like each other. We're definitely geopolitical in a geopolitical struggle, but we don't want to take down the world economy. So we'll give each other time to build out their own industries and eventually get there. But my sense here is that the US chip advantage is so much stronger that China's going to need to improve there before they can fully utilise that energy advantage overall.

Moz Afzal:

Yeah, no, I think you're absolutely spot on. I think the US is certainly far more advanced on that side. One topic I think is really interesting, and certainly we've seen a lot of that in the last 12 months or actually nine months, has been around state capitalism.

It's going to get bigger and other countries and other regions are also going to start building their own in Europe or in parts of Latin America and emerging markets. What are your thoughts around that and where do you think the focus is going to be? Are there any other industries you think are really, really important that the government is going to get involved?

Dan Clifton:

I started my career in 95, 96, which was really the beginning of this globalisation period. So I've only known one way. And that economic policy of the United States was to tell companies, Hey, 3% of your customers in the us, 97% of them are outside the country. Go find them, go globalise. That's all I've known my whole professional career. Now think about what we're saying. Well, we have these chips and we don't want China to have the very advanced chips. They're going to use that against us. So all of a sudden that policy is changing, and the best way to think about it is that we're moving away from an economic policy that prioritised economic efficiency to now one that prioritises national security. That's the big change. So within the context of that, if that's true, then the US government is going to have to build out industries that we have seeded over that 30 year period where under a globalisation model, we want to build out efficient supply chains and we have no problem getting those materials, but Covid hits and we can't get any of that stuff.

So now we're like, whoa, wait a minute here. Maybe we do need our pharmaceutical supply here. Maybe we do need rare earths here. Every time the US has tried to build a rare earth industry, the market got flooded with rare earths which bankrupt these companies. So hey, we'll put a stake in those companies and maybe a stake isn't really the best way to do it. Maybe you got to give 'em cash, but you're building a cushion in those companies to allow them to develop the industry without those market forces really driving them bankrupt. And my sense here is that you're going to see more of this in more critical industries. Number one, it's a signalling event. Some of these are happening in mine permits, mine projects that were never going to get approved. Now the US government owns a 10% stake in it, it's probably going to get approved.

So I think that's the first takeaway. The second takeaway is that the US is saying, we need these resources because we don't have enough munitions for our national defence protection. That's really important piece of data and we're going to build that out. And I do think that we'll be successful on it. If you really want to go down the rabbit hole though, because the US is going to be collecting a return on these investments, it feels like the US is building a sovereign wealth fund and without it being a sovereign wealth fund. And I wouldn't be surprised if something like this in a few years from now gets a second iteration and becomes a way for the US to deal with its entitlement issues in the budget, the unfunded liabilities where all of a sudden now you're getting a higher rate of return on social security by investing in this fund, and that will extend out the solvency of it or prevent what we had to do in 1982, and that was raise taxes and raise the retirement age.

Moz Afzal:

That's very, very interesting. So moving on to midterm and observations around market corrections and all that sort of stuff, do you want to just take us through your thinking on that?

Dan Clifton:

What we notice is that the second year of a president's term, which is the midterm election year, has much more volatility in the equity market than the other three years. What do I mean by that? The average intrayear decline on the s and p 500 in a midterm election year is 19%. It's almost a bear market in year one, year three and year four of a president, the average is 12 or 13%.

So when you look at that, there's something different and special happening in the midterm election year, and I think it goes back to what we talked about at the beginning of this conversation is that presidents love to prime the pump and get growth in year one, and they're largely successful in getting that growth in year one. By the time you get the growth, the breaks get put on by monetary policy. The market has already priced that in, and we're dealing with the grind of thinking about what the new party is going to do once they get in an office. The Democrats doing well. This cycle is nothing out of the ordinary. We've seen in previous cycles where the other party out of power is always winning. So by the time we get to March and April and May, the market starts going, oh, how are we going to raise the debt ceiling in 2026?

Is this going to be impeachment? We talked about foreign affairs being foreign over, this is going to be about impeachment investigation, and there's a lot there that the Democrats are going to go over. So the market's going to start thinking about that next year while you're getting this growth and the market's priced in that growth. And people are going to be asking what now? And I think financial deregulation is what's now, but it's a little bit more removed from this situation. So I wouldn't be surprised. Number one, if you get a bit of a market equity sell off like you've done in history, and it's nothing to fear because it's temporary in nature. Now I say that in 2010 midterm election year, it was the second coming of the financial crisis that never showed up in 2018. It was the Trump's tariffs will never go away and he's going to collapse the world economy.

That wasn't true in 2022. It was Biden's inflation is never going to go away. And of course that got fixed to a certain extent from a financial market perspective, and I'm sure there will be something next year that will do that. But here's the key is that the equity market, the s and p 500 has not declined in the 12 months following a midterm election since 1938. So you just got to grind your teeth out in 2026 midyear. But on the other side of that is a big rainbow. And what happens is by the time we get to the election, the market's figured out all those questions and they're already thinking about how the economy is going to be stimulated for the next presidential election in 2028. That's why I think it works. It works much better in practise in theory, but what's interesting to us is that when you're going through that mid-year election, mid-term election correction mid-year, the equity market just generally gets more defensive, which means you get a market rotation.

So healthcare on average is the best performing sector in a midterm election year and outperforms the S&P 500 by 800 basis points. Healthcare has just been left for dead this year because all the stuff that's happening inside the Trump administration, tariffs, price controls, all that type of stuff, right? The second best sector is consumer staples. There's no one bullish on consumer staples in America, and it's outperformed by an average of 600 basis points. So if history holds, you may see a break in the hyperscalers for a few months and this kind of market rotation more equally weighted over market weighted. But I do think it's temporary until you get to the election and it's back off to the races again as we start to think about the 2028 presidential election.

Moz Afzal:

So one of the other big things that's going to happen in 2026 is the change in the Fed chair. So what's your thinking around that?

Dan Clifton:

Wow, this is as exciting as it gets. So we will have a new Fed chair. Last week, the president basically signalled that he's made his decision and he implied that it was Kevin Hassett on multiple occasions. So the betting markets bid it up like an 80% probability of Kevin Hassett, but I can say I've been watching a long time and when you delay an appointment on one that you say, it tells you there's something up, and they made an announcement last week that they were not going to appoint that Fed chairman make the appointment until January. And the best way to think about that is that's like leaving a pinata hanging out there that can then be hit and delay is not your friend in Washington. Almost immediately after that happened, there was an FT article about how bond investors are worried about Kevin Hassett followed by a Bloomberg article the next day.

So that delay allows this opposition research to come out. What I think is happening, and this is just my gut, is that the president wants Kevin Hassett, he knows him. He's got a relationship with him, and he's very worried that if he selects Kevin Walsh or Waller, he's getting Powell 2.0 at a very critical time for monetary policy next year. So Hassett is his guy. I think there are other people in the White House who think that there might be better candidates for the Fed chairman, and this delay allows time for them to make the case for them. We changed the rules for how you get on a federal agency in 2014. It's taken several years for it to develop, but when you only require 51 votes in the Senate, the Democrats are going to be able to appoint who they want. The Republicans are going to be able to appoint who they want and that's going to make the decisions at the Supreme Court, the Federal Reserve and all federal agencies much more divided, and that's where we are today.

So you're going to need a bit of a consensus builder on the Fed and try and figure out how to continue to get rates cut. Now, Kevin Hassett gets in, he's going to argue that the productivity boost from artificial intelligence is going to lower what the neutral rate would be for the Federal Reserve and that he can continue to lower rates. The problem with that is that he's then got to get Michael Barr and Beth Hammack at the Cleveland fled to agree to that, and they don't buy that argument, right? So you're almost going to get an optimal policy where the Trump chairman is pushing for more rate cuts, but the committee is saying No rate cuts and you end up somewhere in the middle. That's probably about the right policy.

Moz Afzal:

Yeah, certainly going to be interesting and certainly will have an impact on the rate markets as we move closer to the time. So last question, Dan, in terms of anything you think that we just haven't covered or you think that we should really be watching out for in 2026?

Dan Clifton:

Yeah, the Supreme Court decision on tariffs is going to be an important one. I think at the end of the day, tariffs are going to be very similar regardless of how the Supreme Court rules, because Trump has the powers to resurrect those tariffs. But if you get a decision that comes out and says, Hey, Trump, you don't have the ability to do this. The bond market may have a knee jerk reaction where they say, okay, we're going to lose 300 billion of revenue a year. That means higher bond yields. Companies will say, Hey, we're confused. We don't know what the rate is. What should we be collecting? So there could be some near term uncertainty around it. I'm not that worried about it, but I do think that it's a very big event to have the Supreme Court make a ruling on such a wide and vast economic policy overall, and it would be hard to say that there would be no implications for that overall.

The other point that I would make is that this is going to be a very interesting test in 26 with Trump putting himself on the ticket for the midterm elections. Presidents just generally don't do that. So I would anticipate that they're going to hold a Republican convention midyear next year. In a way, it's almost like a presidential election and the president out there trying to campaign, and what's going to be very interesting is whether members of the Republican party want to campaign with Trump. Three months ago it was a no-brainer. Absolutely, I want to be with this guy, and he's very popular amongst the Republican party, but there are going to be some members who are like, ah, you want to be on the ticket? I don't want you on the ticket with me. So you're going to start seeing those fissures. And then third, just as a student of US politics, the 2028 Democratic primary has started way earlier than what we've seen before.

The jockeying that we've been seeing over the last couple of weeks, particularly with Governor Newsom and Governor Shapiro and some of the more progressive wing of the party has been pretty fierce. And so there's going to be talk about 2028 before you even get to the midterm elections, and I think we'll be a pretty big interesting topic as we get into midyear next year about who's going to be those candidates.

Moz Afzal:

Absolutely. So that's a very, very interesting point to stop there. So Dan Clifton, thank you very much for joining the podcast. I wish you a great holiday. A few more weeks to go, but looking forward to 2026 and of course, having you back on the pod and having your unique insights given to us again. Thank you very much. So that wraps us up for today. Thank you for listening to Beyond the Benchmark from EFG, and we'll speak to you again very soon.
 

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