President Trump rallies into the mid-terms

The latest polls show Mr Trump at post-election highs:

Morgan Stanley mulls outcomes:

  • Trade risk is a constant. On election night, focus on other variables. While much is made of election outcomes influencing markets by shifting trade policy, we think this is overstated. Even if Democrats take control, they have their fair share of trade hawks. Hence we see trade enduring as a risk market pressure regardless, and for election night would focus our attention on how other variables are influenced.
  • Fiscal outcomes influence today’s key market variable (rates), driving volatility. Our equity team sees margin pressure from rising costs (namely wages, trade, and interest) as key to stocks. Here, election outcomes could drive very different perceptions, at least in the near term, of the direction of cost pressures by influencing the direction of interest rates. If Republicans hold both houses, the main expected effect is more fiscal stimulus through tax cut extensions. That could drive expectations of higher rates and a more hawkish Fed, applying near-term pressure to stocks. If Democrats sweep, they won’t be able to change fiscal policy before 2020, but it would change expectations of the trajectory beyond it. Winning Senate control means Democrats would have won more than 11 seats in states that voted Republican just two years ago despite polling deficits in some of those areas. That would imply Americans are more supportive of progressive policy than many believe. All of a sudden, it’s reasonable to think about fiscal contraction (i.e., rolling back some tax cuts), albeit after 2020. This shifts the narrative away from rising rates and, in the near term, alleviates the pressure stocks have felt in recent weeks from risks of higher input costs.
  • Consider alternative hedges. Given the case above for volatility, our cross-asset strategists have ideas for you heading into election night. Being long equity vol makes sense, but even more so they like going long DM FX volatility to reflect idiosyncratic political risk of various stripes.
  • Stay cautious in corporate credit. As a relative outperformer, the market hasn’t onboarded many of the nonpolicy concerns that have been key this year’s ‘rolling bear market’ across asset classes. Hence, even if election night drives a constructive near-term narrative for credit, perhaps on tax policy, we would use any rally to continue moving up in quality.

Stocks might actually prefer the Democrats win the House given it takes heat off the Fed. That said, we expect Trump to go for infrastructure in that event so the relief might be brief in the sense of higher interest rates.

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