U.S. Mid-Term Election Carnage Playbook

The U.S. mid-term election is the biggest political event of this year over in the United States. The victory result of this election would not only have an impact on the economic conditions of the United States, but also in several other countries around the globe. I think it may not be wrong to say that these elections would act as a vote of confidence for Mr. Trump. Americans will have a chance to have their say about Trump’s policies and show their support for the president. If we look at the promises he made during his campaign, I think it is safe to say that most of his supporters are very pleased.

But let’s keep the focus on the markets and discuss the landscape for traders on the back of these elections. Historically speaking, mid-term elections do not usually carry much weight and we have not seen any significant impact on the dollar price or the financial markets. What I mean by this is that there weren’t any immediate significant moves in the market as the results were announced. Of course, over the course of  9 or 12 months, the markets reacted to the mid-term election results. Looking back in history since 1922, the market average performance 9 months prior to the mid-term election was 0.3% and 12 months after it was 17.1%.  However, this year we are talking about the Trump administration and given the amount of controversy we have around this government, these elections could for the first time in history bring some unexpected movement in the financial markets.

The U.S. economy is in a much stronger shape and this is a key reason that we have not seen much of the risk off trade kicking in. For instance, the dollar index has traded mostly lower against major pairs except against the Japanese Yen and the Swiss Franck. Looking at other risk-averse assets such as VIX (the SPX volatility index), it has eased off from its highs of $25 to $19.86. The precious metal is also trading near its $1,230 level from its previous high of $1,240. The U.S. Federal Reserve Bank hasn’t shown any concern about the mid-term elections either. This strengthens the argument that the Fed has every plan to remain on the interest rate hike path.

In the absence of important economic releases today, the focus remains on the U.S. mid-term elections. So, what should traders expect and how do they trade it?

According to the latest polls, the Democrats could take control of the House and the Republicans would continue to control its majority in the Senate. However, polls are nothing but indications and by learning from the past, one cannot rely on them entirely.

Nonetheless, one thing is clear. The Republican-controlled Senate is good for the dollar bull rally purely because they support Trump’s ideology. In other words, if the Republicans take the control of both governments, it would be highly positive for the dollar because this means that the Trump policies will prevail. In terms of target levels, the dollar-yen pair could easily touch the level of 114 and the euro-dollar pair could drop to 1.1350. Both figures have significant importance because major support levels are there. Similarly, the equity market could continue to move higher and the bull momentum could easily push the indices like of S&P500 and Dow Jones to several new record highs.

If the Congress is split, Republicans in the Senate and Democrats in the House, this would simply mean gridlock for future Trump policies. The President wouldn’t be as likely to see his policies becoming a reality – like a lower tax for the middle class along with several other controversial policies which he holds in the pipeline. However, the bearish momentum or the sentiment may not last long as the focus would shift towards the overall conditions of the economy which is strong. The worst-case scenario for Trump administration would be where Democrats control both the House and Senate. This could push the dollar index significantly lower and the equity markets into the bear market territory.