NEW YORK (Reuters) – Gridlock, Blue Sweep or Red Repeat? Wall Street is watching attentively next week's US Congressional elections, as policy decisions that can affect the economy, business decisions and consumer spending depend on the results.
Traders work on the floor of the New York Stock Exchange (NYSE) on October 30, 2018 in New York, USA
Should its Republicans maintain or expand Congress, President Donald Trump could be encouraged to pursue more of his political agenda, including further tax reforms.
In contrast, democratic achievements that allow the party to control the House of Representatives and possibly the Senate could stifle Trump's political goals and possibly lead to attempts to blame him.
Investors are campaigning for a divided Congress in which the Democrats win the House, but the Republicans are the Senate, a mirror of current polling data and online betting markets.
However, sentiment may change in the last week before the November 6 election, and investors are quick to remember that Trump lost in surveys ahead of his surprise victory in the 2016 presidential election.
Congressional Election Election "Generally speaking, this is not an important event on the US market, let alone an event on the world market, but it may be different this time," Citigroup analysts write recently.
Here's how the election results can affect different asset classes:
A democratic takeover of the House could alarm the stock market for fear of political instability, including hearings by the Trump administration.
However, the decline in US stock prices this month could lead to a price surge in such a split Congress, so the scenario may not shake the market significantly.
Even if the Democrats win the parliament, the stalling of the legislature could reduce the chances of important political changes if the Republicans retain control of the Senate.
However, an infrastructure spending package is an area where Trump and Democrats could find a compromise that strengthens equities.
A democratic momentum from the House and Senate would probably surprise the market and lead to a sell-off of equities.
The potential for Democrats to change Trump's tax reduction package or initiate impeachment could undermine the trust of investors and companies.
Winning the Republicans, allowing them to retain full control of Congress, could lift stocks as it would increase the chances of further tax reform and further deregulation.
However, the market would keep an eye on the Federal Reserve if Congress continued to boost economic growth through further tax cuts or spending, which could increase inflation and lead to higher interest rates.
A Republican victory could also encourage Trump to pursue his protectionist international trade policy with even more import duties.
"The initial response may be positive, but there are some potential negative consequences if the governance guidelines are not really reviewed," said Rick Meckler, Partner at Cherry Lane Investments of New Vernon, New Jersey. "This policy, both in trade and in taxes, was quite inflationary."
If the Republicans keep both the House and the Senate, the US dollar could benefit, analysts said. With the disruption of international product lines and rising input costs due to the Trump tariffs, the dollar will be perceived as a safe haven and strengthened after this year's levies on Chinese, European and Canadian imports.
However, analysts said a divided Congress would be negative for the dollar as it is unlikely that any new fiscal stimulus will be introduced to offset the predictions of slowing US economic growth next year.
A Congressional Democratic Congress could also undermine the dollar if it brought Washington DC to a complete standstill, increasing the risk of government shutdowns and suggesting a more volatile political environment ahead of the US presidential election in 2020.
A Democratic Congress could undo some of Trump's trade policies and help other currencies, such as emerging markets, analysts said.
The outlook for emerging markets depends on the strength of the US dollar and tensions in trade policy. Emerging market assets are likely to be reversed after the elections in response to the development of the US dollar.
A democratic takeover of one or both chambers of Congress would reduce tensions in trade talks with China, said Bertrand Delgado, director of emerging markets at Societe Generale in New York.
A Republican sweep could lead to a sell-off of emerging market assets as the international trading room is expected to continue. China has been the most heavily weighted in emerging market equities after economic growth eased due to the trade war with the United States.
If the Democrats use one or both chambers of Congress, further efforts to amend tax legislation are likely to stall, but Democrats may not reverse the republican tax cuts passed in December or increase spending on social programs.
As a result, the federal deficit is unlikely to grow faster or require additional credit than currently projected. This could be slightly positive for bond prices.
"We are looking for a split government, which means nothing is done," said Gennadiy Goldberg, interest rate strategist at TD Securities in New York.
One caveat: If a split government as a bargaining tool leads to a government deadlock, this could lead to safe takeover bids for US government bonds.
If Republicans keep their lead in Congress, the fiscal outlook will be hampered by how they tackle the budget deficit.
You could try more tax changes, which can increase the deficit. Any changes can be compensated by attempting to curtail the entitlement programs or terminate the Affordable Care Act, although the net impact on government borrowing is unclear.
Reporting by Lewis Krauskopf, Gertrude Chavez-Dreyfuss, Rodrigo Campos and Richard Leong; Editing by Megan Davies