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US midterm election impact on Capital markets : Probable outcomes and Market reaction

Washington has helped shape global markets over the past 12 months, whether it is the US corporate tax cut or Donald Trump’s trade war. Tuesday’s midterm elections have 3 possible outcomes.

(1) Republicans retain the senate and lose majority in the house : The mostly likely outcome by pundits is probably the most boring because it keeps fiscal policy, regulation and trade policy constant. If the consensus expectation for the election result unfolds,the market reaction is likely to be neutral to mildly positive on US markets, US Dollar with more steepness in US Bond yield curve. If one looks at betting models, there is a 60-65 % chance that Democrats take the House and Republicans keep the Senate.

(2) Democrats win both Senate and House : Should Democrats outperform expectations and take both houses, some investors worry that the risk of impeachment rises. It is also likely to eliminate the possibility of further tax cuts and may embolden efforts to roll back some reductions already made. US Markets should go lower with lower risk appetite, US Dollar should also fall along with fall in long dated bond yields ( flattening of the curve)

(3) Republicans keep both Senate and House : Conversely, if Republicans surprisingly keep both House then US equity markets are coiled for a run on upside with possible new high (magic figure of 3000 on S&P) in US stocks, helped by hopes of an easier path to further stimulus. US Risk assets will rally at the expense of Emerging Markets and US trading partners as markets will perceive investors have voted in favor of Trump policy and he will most likely continue on that path .

Whatever is the result ,brace for high volatility going into the election results as most global portfolio managers have underperformed their benchmarks this year  and they would be happy to jump into the bandwagon to eek out that missing alpha.

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