Dollar Faces ‘Slow Burn’ If U.S. Midterms Produce Split Congress

(Bloomberg) -- Next month’s U.S. midterm election could “reset” the dollar for the worse if the vote results in a split Congress and stalls out fiscal initiatives that lure capital to U.S. assets, said Mazen Issa at TD Securities.

“A divided government may eventually sow the seeds of uncertainty,” the senior FX strategist said in an interview. “We could see a resumption toward a convergence theme -- one that puts less emphasis on U.S. exceptionalism.”

Until recently, U.S. equities have outperformed most of the world, attracting global cash to the dollar. But political gridlock could diminish policy action and fiscal support for American assets, meaning the re-emergence of themes that undermined the greenback earlier this year and in 2017, Issa said. A shift in focus to opportunities outside the U.S. could redirect capital flows, he said.

That may lead to a “slow burn” for the dollar, and money managers would likely see a greater emphasis on foreign forces, such as the policies of the Bank of Japan and European Central Bank, he said.

Dollar Faces ‘Slow Burn’ If U.S. Midterms Produce Split Congress

In the divided Congress scenario, Issa sees the dollar-yen exchange rate as a short bet for the end of the year and recommends wagering against the dollar when the greenback rises toward 113 yen, with critical support near 111.60, according to a client note.

The dollar-yen “could become the next big short to close out 2018 as far as the USD is concerned,” he wrote.

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