So far, so good for Wall Street’s midterm election forecasts.
Generally speaking, consensus was that should the expected outcome play out, the dollar would be on the back foot, equities would do well, and the curve would flatten.
The rationale behind those calls was relatively straightforward. Gridlock would stymie Trump’s “worst” impulses when it comes to escalating the trade war or otherwise overreaching, while GOP retention of the Senate would ensure the market-friendly aspects of the President’s policy platform are not affected. That’s bullish for U.S. equities.
Dimming prospects for another large round of fiscal stimulus mean lower long end yields and a weaker dollar, with the latter helping to shore up a beleaguered EM complex that really – really – needs a break from greenback strength.
All of that is playing out on Wednesday. The dollar is lower, helping to buoy EM FX, U.S. equities were higher in early trading and the 2s10s is on pace for its biggest one-day flattening since May.
Now that everybody has had a few hours to digest the results and think about the implications, it’s worth running through some excerpts and highlights from Wall Street’s morning takes.
“From a policy perspective, our economists do not expect any new initiatives on taxes or infrastructure, as it is likely to be hard to find plans that will be acceptable to both parties”, Goldman writes, recapping a longer piece and adding that “spending plans are unlikely to deviate much from their current assumptions.” That’s probably a good thing, because currently, this administration is spending its way to trillion-dollar deficits.
Goldman continues, noting that when it comes to trade, “we do not expect the outturn of the midterm election to change the trajectory of US-China relations [and] and while that is reflected in the performance of many China-linked assets, it does not appear to be priced in front-end inflation swaps for instance.” Goldman still expects a post-midterm rally in U.S. stocks as the removal of uncertainty bodes well.
For BNP, the outlook for trade tensions is unchanged. “Presidents derive their trade powers from existing legislation, specifically the Trade Expansion Act of 1962 and the Trade Act of 1974 [and] to override these powers, it would likely take new legislation to be passed by both the House and Senate, along with a two-thirds vote in both chambers to override a likely presidential veto”, the bank reminds you. So, again, hopes for Trump to be reined in on trade may be misplaced.
As far as markets are concerned, BNP is sticking with a generally bearish view on the dollar, though they note that Wednesday’s knee-jerk “likely reflecting the closing of positions put on in anticipation of a possible surprise Republican sweep.” For equities, the bank sees the S&P consolidating “in the middle of the recent 2650/2820 trading range”, although they appear to agree with SocGen that the overall trend in volatility should be higher. For rates, the bank reiterates a flattening call.
Writing in a note out early Wednesday morning, BofAML also reiterates a call for continued flattening in the curve. “Democratic control of the House should lead to lower long end rates and modestly flatter yield curve”, the bank writes, adding the following:
The downside risks to our 10Y forecasts stem from gridlock in DC. This should limit policy action to the bare minimum of raising the debt ceiling and keeping the government funded, which should result in modest budget increases. The split Congress also raises risks of political acrimony and divisiveness which could weigh on business and consumer confidence. This should result in fiscal policy becoming less of a tailwind and further expectations for a gradual deceleration of growth in the near-term.
For their part, Well Fargo says that “unlike 2016, we do not currently believe the 2018 midterms will spark policy outcomes that provide a significant boost to growth and a subsequently more hawkish Fed.” The bank essentially reiterates the notion that a divided government is a government that will have a difficult time passing sweeping legislation, which means the outlook for the deficit and, by extension, for issuance, is unlikely to change.
“For Treasury supply, our base case is for the deficit to continue widening over the next few quarters, but for the pace of widening to slow by H2-2019”, Wells writes, adding that they’re looking for “a budget deficit of $1.05 trillion in FY 2019 and $1.1 trillion in FY 2020.”
You can take all of that for what it’s worth. I guess what I would say about equities is that while a kind of “muddle through” dynamic is certainly possible under divided government, nothing has really changed in terms of the outlook for Fed policy which means we’re probably still searching for the new equilibrium on the elusive “Powell put”.
On the dollar, a cloudy outlook for more stimulus means the day of reckoning for the greenback when it comes to responding to America’s “deplorable” fiscal trajectory may come sooner rather than later – especially if the Fed ends up hiking the economy into a downturn, on the way to doing an abrupt about-face and cutting rates while the deficit balloons.