How will the election hit the currency market (aka the only market that matters anymore)?That’s the topic of a note from Citi’s Greg Anderson:
According to all the major pollsters and analysts, the US House of Representatives will be in Republican hands shortly. Reuters reported yesterday a joint poll with Ipsos that predicts the Republicans will go from a 256-178 deficit relative to the Democrats to a 231-204 majority. A Gallup poll predicts the Republicans will win 60+ seats, which would give the Republicans at least a 238-197 majority. Widely followed political scientist Larry Sabato of the University of Virginia predicts the Republicans will add 55 seats to show a 233-202 majority.
Reuters/Ipsos predicts that Democrats will retain control of the Senate by either a 52-48 or 53-47 majority. Sabato predicts the lead will be 51-49, but notes that five of the last six times the House flipped, the Senate did too, so he puts it in the realm of possibility that the Republicans could gain control of the entire congress. The most critical Senate race is in Nevada, where Senate Majority Leader Harry Reid is in a race that pollsters are saying is too close to call. A loss by Reid, even if the Democrats retain the Senate, would put new leadership in place and potentially change the Washington dynamic.
Foreign exchange markets have paid very little attention to the election with QE2 absorbing so much attention. However, the election has the potential to roil the USD over the short, medium and long term. In the short term, the question is whether there will be a ‘hanging chad’ type of crisis in Nevada or elsewhere. There have already been sporadic news reports of computer glitches and other problems. If this race ends up so tight that it requires a re-count and control of the Senate hangs in the balance, then this has the potential to blow up in to a fiasco that leaves a leadership vacuum and an air extreme partisanship during precisely the small window when Congress is supposed to find some type of compromise on rolling back the expiry of the Bush tax cuts. Presumably this would be short-term USD-positive because it would bring a new bout of risk aversion, although it is conceivable that a US election crisis may make the USD lose out to JPY, CHF or EUR as a safe haven.
For the medium term (through next January), a big Republican landslide that extends to control of the Senate and House could presumably also cause problems because it would leave outgoing Democratic leadership to resolve the Bush tax cut extension. Chances of a hiccup that leads to no extension and therefore an economic disruption during December and January would be greater.
For the long term, a landslide Republican victory would presumably lead to greater pressure for the federal government (and also local governments) to cut spending. If the Republicans have a convincing deficit reduction plan, FX markets will presumably view it and the USD favourably, as they have with the UK and GBP. However, if markets become convinced that gridlock in Washington will lead to Republicans unwillingness to raise taxes and the Obama Administration unwillingness to cut spending, then a sweeping Republican victory could become USD-negative by Q1 next year. Sovereign debt/deficit dynamics are likely to re-assert as a driving FX theme at some point next year.
We’d take issue with a few things.
For one, it’s really not the end of the world if Senate control is in doubt for a little while, and as long as the House is GOP, we know we’ll get the gridlock everyone is expecting.
As for the latter part about fiscal discipline being good for the dollar, we’re not sure about that either. The lack of fiscal stimulus only puts more pressure on the Fed to find creative ways to print and stimulate, which is dollar negative.