U.S. Elections: Contested outcome to trigger a USD rally - Capital Economics

FXStreet notes that over recent weeks, equities have rallied and bond yields have risen on occasions when the perceived chance of a Democratic win has gone up, and vice versa. As the election campaign draws to a close, economists at Capital Economics looks at how it has affected so far and assesses how different outcomes could affect equity, bond and currency markets after Election Day. 

“A win for their candidate for president, Joe Biden, combined with a ‘Blue wave’ sweep where Democrats won majorities in both the House of Representatives and the Senate, is perceived as the outcome that would deliver the largest fiscal boost and therefore the most help for risky assets.”

“Investors may be overly optimistic about how much stimulus a Biden administration would deliver, and how quickly it would get through Congress even with Democratic majorities in both houses. We also think that any further rise in US Treasury yields, if there was a large fiscal package, would not be sustained. We expect that the Fed will continue to keep yields low regardless because it wants financial conditions to remain accommodative while the economy recovers from the COVID-19 shock.”

“A surprise sweep for Republicans (which looks very unlikely) could well lead to a broadly similar market reaction as a Democratic win. They too would probably pass another stimulus package, albeit a smaller one, and continue with the generally business-friendly policies of the past four years. That said, a second term for President Trump would probably be bad news for some emerging market currencies – in particular, the Chinese renminbi – due to the risk that he may again ratchet up trade tensions again.”

“The worst outcome for investors would be if either side contested the outcome of the election. That would reduce the near-term prospects for a fiscal deal and increase uncertainty more generally. It could easily trigger a deeper setback for risky assets and a rally in safe havens, including the US dollar.”