Fra BNP Paribas:
KEY MESSAGES
The mid-term elections met consensus
expectations for split control of Congress.
With Democrats in control of the House there is a
greater risk of government shutdowns, little
legislative progress, investigations into the Trump
administration and risk of stronger rhetoric on trade.
Markets will likely have a muted response after
some pre-election positioning is reset.
Democrats win House, Republicans keep Senate:
We expect the new Democratic House majority to
exert substantial oversight of the Trump
administration, most visibly by opening multiple
investigations, which will likely take a toll on the
executive branch’s resources, both in terms of time
and personnel.
We expect little to nothing legislatively,
as Democratic and Republican priorities differ, and it
is likely that President Trump will be eager to make an
antagonist of a Democratic House in the run-up to the
2020 election. This would likely raise the risk of
government shutdowns, especially if President Trump
judges he could blame a Democratic-led House for
the problems.
On the fiscal side, while it is possible
the Congress could reach an omnibus spending bill
similar to the one passed this year, differences in
priorities between the Democrat and Republican
leadership could result in reverting to stop-gap
continuing resolutions (CR’s) – meaning no new fiscal
stimulus – to keep the government funded.
Trading blows:
We see little scope for a Democratic-led House to
reign in President Trump on trade. Presidents derive
their trade powers from existing legislation,
specifically the Trade Expansion Act of 1962 and the
Trade Act of 1974. To override these powers, it would
likely take new legislation to be passed by both the
House and Senate, along with a two-thirds vote in
both chambers to override a likely presidential veto.
While it is possible some moderate Republican
senators could join a Democratic House in producing
such legislation, we see that as unlikely. Moreover,
while Democrats have de facto become the
institutions and rule of law party, the political cost of
taking on the mantle of free trade may outweigh the
benefit (although seeking to reign in the President
from alienating allies could be the rationale they
choose if they move to do so).
FX: We expect minimal initial impact in currency
markets, with more immediate USD weakness likely
reflecting the closing of positions put on in anticipation
of a possible surprise Republican sweep. Looking
beyond this week, we see increasing USD vulnerability
as we move into 2019. We remain broadly bearish on
the USD as we head into year-end, and look for
recovery in EURUSD back towards 1.20 and weakness
in USDJPY through 110 in the coming weeks.
Rates: We expect a muted reaction from rates and
swap spreads. The biggest near-term impact is likely to
be a correction lower in short-dated implied volatility.
We expect the curve to flatten as the Fed does not hike
beyond Q2 in 2019. Over the next 6-8months, we
expect 2s30s Treasury curve to reach 0bp, 10y UST to
outperform 10y OIS swaps by 10-15bp and 7y
breakevens to recover by 10bp or more after their sharp
recent cheapening.
Equities: We expect the S&P500 to consolidate in the
middle of the recent 2650/2820 trading range. In the
very short term though, we expect to see volatility
compression and the S&P500 term structure to continue
to normalize. Longer term we expect the trend in equity
volatility as to be higher.
