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Markets quiet ahead of US election

By David Morrison  |  06/11/2018 15:16
”US

Investors are sitting on their hands ahead of today’s US mid-term elections. Latest polling suggests Republicans hold Senate but lose majority in House of Representatives

US voters go to the polls today in what is being viewed as the first major ‘satisfaction measure’ of Donald Trump’s controversial presidency. All 435 seats in the House of Representatives are being contested along with 35 out of 100 Senate seats. The latest opinion polls suggest that the Republicans will hold on to their wafer-thin Senate majority while the Democrats look likely to win back control of the House. If so, then this means that Congress will once again be ‘gridlocked’ which many commentators believe is the best outcome for the US. It is often argued that gridlock helps to curb the worst excesses of US politicians., although this very much depends on the issue under debate.

More fiscal stimulus?

Anyway, as far as domestic issues are concerned (bear in mind that the President makes his own decisions on international matters without recourse to Congress) it appears overall that both Republicans and Democrats are equally keen on fiscal stimulus. The main disagreement seems to be over what the money is spent on. Republicans favour ‘defence’ while Democrats prefer welfare, although it’s possible that both parties get together to agree a new infrastructure spending package. Bear in mind, any such move will only raise the likelihood that the Fed picks up the pace of monetary tightening in response to the prospect of rising inflation. Of course, Democrats may push for tax hikes on the ‘rich’ but that’s unlikely to get much traction and anyway Trump has a veto. And it would certainly be ironic if the Democrats tried to call out the President on the ballooning trade deficit. It’s unlikely that they would vote against an increase in the US’s debt ceiling next year, although they may do so to make life difficult for Trump.

US/China trade dispute

As to the trade dispute with China, as mentioned earlier, this is something that Trump can drive without recourse to Congress. In any case, Trump’s approach to China has support across the party divide. But if the Democrats get a majority in either the Senate or the House of Representatives, then they could disrupt the approval of other trade deals. Meanwhile, a clean Democratic sweep would also raise the prospect of a move to impeach the President. But as investors continue to shrug off concerns over the Mueller investigation into Russian interference in the 2016 Presidential Election and possible ties to the Trump campaign, there is likely to be little reaction to impeachment talk.

Market reaction

SocGen have put out a handy cheat-sheet about the likely market reaction to the three possible outcomes of today’s vote. Firstly, the most likely result of a Republican Senate and Democrat House should, they say, see a spike in equity market volatility before investors once again fret about tighter monetary policy from the US Federal Reserve. They see a limited reaction from the dollar, although they expect it to weaken going into next year. If the Democrats were to capture both the Senate and House, then SocGen expects both the dollar and US stock indices to decline sharply, at least initially. However, this could reverse if both sides start to talk up a fresh programme of infrastructure spending.  The only fly in the ointment is if the bond market sells off on the prospect of unfunded spending promises which will add to the budget deficit and national debt. If the Republicans manage to hold the Senate and the House, then SocGen says we should expect the dollar to rally sharply along with equities. But they caution that an equity market bounce could be short-lived as investors once again focus on a continuation of the Fed’s rate hike cycle into next year.

Problems persist

But there are bigger issues for investors to tussle with which aren’t going to be solved instantly by the mid-terms, whoever claims victory. Not only will the US/China trade dispute continue to fester, but we also have the vexed issue of the economic deterioration across the Euro zone. This is a serious issue, particularly when the stand-off between the European Commission and the Italian coalition government over the latter’s deficit-busting spending plans are considered. This comes against a backdrop of the European Central Bank less than two months away from halting its monthly bond-buying programme and as the Federal Reserve continues to tighten monetary policy.

S&P 500 – technical outlook

Focusing on the S&P 500, the index remains trapped between two significant levels. Firstly, last week it broke back above support around the 2,700 level which is broadly positive. But it continues to trade below its 200-day exponential average (EMA) around 2,760 which is negative. Also weighing on sentiment is the fact that the 50-day EMA has just crossed below the 100-day EMA, something which typically signals a change in trend/momentum from upward to downward. The last time this happened was in January 2016 after the Chinese authorities devalued the yuan.

Key levels
Going forward, bulls are looking for a break and subsequent consolidation above the 2,760 200-day EMA while bears will want to see a concerted move back below 2,700. The problem is that any volatility following the mid-term election results is likely to complicate the picture. So perhaps the wisest course of action is to wait until this peripheral noise dies down, especially ahead of the culmination of Fed’s two-day monetary policy meeting on Thursday.
 
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