The U.S. Capitol building stands past a runner pausing at the Washington Monument in Washington, D.C., U.S. (Photographer: Andrew Harrer/Bloomberg)

U.S. Midterms Pose Big Risk for Markets, Standard Chartered Says

(Bloomberg) -- Investors had better start paying more attention to November’s U.S. midterm elections, according to Standard Chartered Plc.

As the campaign for control of Congress enters a crucial phase, Republicans defending seats in some of the most competitive races in the House of Representatives have more cash on hand than their Democratic challengers, a Bloomberg tabulation of Federal Election Commission reports shows. But polls, turnout and fundraising show Democrats have a credible shot at winning the House in November.

Should Democrats regain majorities in the House or even the Senate, it could put them in a position to step up scrutiny of President Donald Trump’s administration and might raise the likelihood of Congressional gridlock that slows the president’s policy initiatives.

“The stakes are very high for President Donald Trump,” Philippe Dauba-Pantanacce, a global geopolitical strategist at Standard Chartered, said in a July note that preceded predictions in a separate report this week. “The election is being increasingly framed as a referendum on Trump and his Republican majority in Congress.”

Here’s how Steven Englander, the bank’s head of global G-10 FX research and North America macro strategy, sees four election scenarios playing out in markets, according to an Aug. 6 note:

Republicans hold the House

Should Republicans hold onto the House and Senate, it would likely keep the president’s policy program in play, supporting the dollar and stocks. Bond yields would probably rise given the administration’s focus on stimulus and lack of emphasis on fiscal deficits.

Republicans lose the House by fewer than 10 seats

A change in House control would probably trigger a short-lived selloff for asset markets and the dollar, but market participants would eventually take a less negative view given incumbent parties tend to lose large numbers of seats in midterms.

Democrats have a 10- to 35-seat win

Englander calls this outcome the "grey zone" which would reduce prospects for legislation and raise uncertainty for the 2020 election. Investors would need to weigh whether this scenario is a signal of a Democrat swing or a normal mid-term swing that could be reversed in two years.

Republicans lose by a lot: Democrats take a 35+ seat majority

This would be the “most difficult” result for markets, suggesting a potential Republican loss in 2020, Englander writes. “This is not the only possible scenario, in our view, but it is plausible, as it would suggest a big popular vote swing for Democrats. We see little evidence that investors are considering this scenario, so it probably would have the most dramatic effect.”

A resounding win for Democrats could mean a gradual decline for equities, reduced expectations for Federal Reserve rate increases and lower Treasury yields, according to Englander. It might also translate to support for Group-of-10 currencies and rates-sensitive emerging markets, he said.

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