US midterm election is mostly a political event
Trump's first real political test is on Tuesday 6 November, when the midterm elections take place. While media coverage is going to be intense, we think the election is mostly a political event not an economic event , which we discussed in depth in US Midterm Elections - Mostly a political event with limited implications for markets and the economy , 4 September. We believe the US expansion is set to continue in coming years , as optimism remains high and fiscal policy remains expansionary.
The most likely outcome is that the Democrats win the House but the Republicans retain Senate control . This would make President Donald Trump a 'lame duck' in the sense that he cannot get through with his domestic agenda. Trump's focus would remain on foreign and trade policy. If the Democrats win the House, we believe they are likely to start an impeachment process against Trump. While this would create a lot of headlines and noise, we do not think Trump would be convicted, as this requires a super-majority in the Senate (impeachment is a political, not a legal, verdict).
Even if the Democrats win control of both chambers, it would be difficult for them to roll back Trump's laws/policies , as Trump can veto any attempt to do that, which should limit the immediate impact on US Treasuries. The higher government deficits ahead would increase US Treasury issuance and put upward pressure on long-end US yields . The midterm elections are also unlikely to change the Fed's outlook despite Trump's criticism. The flattening of the US yield curve remains the main focus.
EUR/USD and real rates have moved apart under Trump. In a scenario where Trump ends up a 'lame duck' after the midterms, it could support the USD somewhat (and weigh on EUR/USD), as the 'Trump discount' may start to be priced out. History suggests that the midterm elections are secondary for equities. We are positive on equities, as returns are more dependent on macro than politics, although volatility may be higher.
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