Forecasts for the U.S. Dollar in the Wake of the Mid-terms

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The Dollar was forced onto its back foot Wednesday after opposition Democrats captured the House of Representatives in the U.S. midterm elections.

Democratic Party candidates secured 219 of the 435 seats in the House of Representatives, up from 194 and leaving them with a majority in the lower chamber. Republicans won only 193 seats, down from 241.

Democrats saw their position in the Senate pared back following the ballot, with independents and Republicans having made gains. Republicans still control the upper chamber.

Opposition Democrats now have 45 of the 100 seats when two allied-independents are included in their numbers, while Republicans have 51 seats.

This is significant for the Dollar because a split Congress will slow the legislative process and make  it more difficult for further fiscal stimulus, like tax cuts or spending bills, to get through Washington. 

President Donald Trump's tax cuts were instrumental in firing up the economy this year and it was U.S. economic outperformance that made the Dollar resurgent in the first place. 

In addition, Democrat control of the House gives them the authority to issue subpoenas and launch committee investigations into all manner of things, including President Trump's tax affairs.

However, analyst differ in their views about just how important the election outcome will really be for the Dollar once into the New Year. Below is a compilation of comments drawn from across the analyst community. 

The Dollar index was quoted 0.58% lower at 95.69 Wednesday and is now up just 3.6% for the 2018 year after paring back what was a 4.5% gain at the beginning of the week.

The Pound was 0.38% higher at 1.3162 against the Dollar but is down -2.46% in 2018 and the Euro was up 0.45% at 1.1494 and has declined -4.17% this year.

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Chris Turner, head of FX strategy at ING Group 

"While it is tempting to say that this result was already priced in, we do think a divided Congress does have some important implications for the dollar going forward.

"The vastly reduced chances of fresh U.S. fiscal stimulus will re-emphasise the U.S. as a late cycle economy heading into 2019 (along with a flat or even inverted curve) and suggests to us the Dollar will top out in the 3-6 month window rather than a 6-18 month window, which would have been the case on a fresh tax cut.

"The loss of the fiscal stimulus option will probably see greater incentive in Washington to talk the Dollar lower – either indirectly through pressure on the Fed or perhaps more direct references to FX. We suspect we could see some further modest Dollar declines.

"We prefer the high yielders, because after Thursday’s FOMC, the market will turn its attention to the prospects of a US: China trade deal at the end of this month." 

Kit Juckes, chief FX strategist, Societe Generale

"At the margin, the outcome of the Midterm elections in the U.S. will be to hinder further fiscal easing, increasing the likelihood that the economic cycle is peaking, but leave the President free to continue his trade policies. In all, that's a slight negative for the Dollar, though not against the most trade-sensitive currencies.

"The Yen ought to benefit, the Euro and Sterling are enjoying a relief rally, but concerns about trade, and about China and the outlook for the CNY, will remain.

"The Euro is now snuggled into tis 1.13-1.18 range, but the top of it feels a long way away. Better German and Spanish data yesterday was offset by soft Italian data and Italian political concerns aren't going away. The Canadian dollar still looks cheap to me, but the elections and the price of oil both count against it. Frustration will continue and a return to levels below USD/CAD 1.30 isn't imminent."

Ulrich Leuchtmann, head of FX strategy, Commerzbank 

"A Republican majority in both houses would probably have cut taxes and not lowered fiscal spending proportionately. The U.S. would have become more attractive for investment, the demand for the U.S. currency would have risen. However, this is unlikely to happen now. That is the lesson we have learnt from different majorities in the different chambers of Congress: the two chambers block each other thus making public spending more difficult.

"A less expansionary fiscal policy also means (and that is the channel through which the election is having an indirect effect): inflation pressure, that might arise from the combination of expansionary fiscal policy and protectionist trade policy, is less likely. A scenario, in which the Fed will have to hike its key rate (as was the case in previous rate cycles) well above the equilibrium level, seems less likely.

"That means one less USD-positive argument. However, I urge caution: in the area of trade policy the administration can act more or less independently from Congress." 

Mickey Levy, chief Americas economist, Berenberg Bank 

"We expect the highly partisan and polarized next session of Congress with split powers between the two political parties to lead to significant political rancor and theatrics but little meaningful legislation.  We expect even more Congressional dysfunction ‑ if that is possible ‑ to lead to more convolutions in the already dysfunctional budget process and more threats of government shutdowns.

"Markets should be comfortable with a Split Congress that allows for additional Congressional checks on Trump and a continuation of fiscal policy and ongoing deregulation that has lifted economic growth in over the last couple of years. But eventually the market reaction will be influenced by perceptions of the 2020 presidential elections.

"A lot can change in two years, but the midterm election results do not necessarily increase the perception of a shift to the hard-left in the 2020 elections and a roll-back of the Trump Administration’s pro-business policies. As a result, a jarring of confidence in stock markets and drop in business investment and hiring seem unlikely.

"Historically, stock markets have appreciated in the year following midterms. This is true of midterms in which the President party lost one or both Chambers of Congress.  In 2010, when the President’s party lost control of the House and maintained the Senate majority, equity markets rallied for eight months."

Andrew Hunter, U.S. economist, Capital Economics

"The Democrats were widely expected to win control of the House in yesterday’s midterm elections and the results set the stage for two years of legislative gridlock. President Donald Trump and the Democrats could work together to boost infrastructure spending, but there is probably more chance of an extended government shutdown. That said, the midterms will do little to derail Trump’s protectionist agenda.

"With Congress divided, Trump and the Senate Republicans won’t be able to make any major legislative changes without the approval of Democrats. As we argued before the elections, this means that the Republicans’ hopes of a second round of tax cuts are probably now dead in the water. (See “Midterms unlikely to lead to another fiscal stimulus”, sent on 29th October.) That may explain the modest softening in the dollar and decline in Treasury yields this morning.

"Overall, the midterms are unlikely to have a significant bearing on the economy. But they probably raise the risk that political uncertainty once again becomes the dominant theme over the next couple of years."

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