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All Eyes on US Midterm Elections

Investors are tense and undecided into the US midterm elections today.

US President Joe Biden didn’t have an easy mandate. The Covid pandemic, the war in Ukraine, the global energy crisis, the skyrocketing inflation, a pitilessly tighter Federal Reserve (Fed) policy, rising mortgage rates… all these factors will weight on the wrong side of the balance for Democrats at today’s election.

The consensus expectation is a divided government between White House and Congress. Republicans are favoured to take the House and have at least 50/50 seats at Senate.

What does that mean for the US monetary and fiscal policies, the financial markets, and the dollar?

Nothing will change for the Fed

The midterm elections won’t change anything for the Fed policy. The Fed will continue fighting inflation on its end. It will continue tightening its policy, raising the rates – by slower increments but as high as needed to bring inflation back on – at least – a healthy path toward its 2% policy target.

The divergence between a strongly hawkish Fed stance, and reasonably hawkish other central bank stances should continue tilting the balance toward a strong US dollar.

How strong the dollar will be against the majors will depend on how hawkish the central banks of other currencies are, and what shape the US fiscal policy will take.

Fiscal policy will get impacted

The changing landscape in the government will of course have an impact on the way the political decisions are made in the US, and on the way the US debt is managed.

The Fed’s aggressive rate hikes make the huge US debt more expensive by the day. The US debt to GDP ratio stood at a touch below the 125% mark in June this year. And it’s increasing steadily – something Republicans don’t like.

Therefore, the US debt burden could stop the Democrats from putting in place many economic reforms that they would’ve otherwise, if Republicans are sufficiently crowded to block them moving forward. Hence, slowing debt under GOP could slow growth.

Therefore, if Republicans win control of both House and Senate, we should see the US treasuries rally and the dollar soften, whereas if the Democrats hold on to the House and Senate, we shall continue seeing a positive pressure on the dollar.

Every outcome is better for stocks than a Democrat majority

A Republican majority in both chambers should boost equities, more than a Republican majority in both chambers, or a split government.

On the other hand, empirical data shows that the US stock markets performed better with a divided government in the years following a same party controlling the Senate, the House and the Presidency.

That means that even a divided government would be better than a Democrat majority for the US stocks.

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