US Election Countdown: T-minus six days - Scenarios and market reaction.

Macro 8 minutes to read

John Hardy

Head of FX Strategy

Summary:  In the US election countdown piece, we look at five different scenarios for the US election, for everything from a very unlikely Trump win to the most extreme Blue Tsunami scenario for the Democrats. For each scenario we take a stab at how the US dollar and major asset classes might react.


This is the second in a daily series of articles I will run through Election Day next Tuesday and for as many days after that day that are necessary until a result is clear. Today I look at:

  • My take on US election scenarios and the approximate probabilities
  • How the election outcomes might impact the US dollar and other major asset categories

In yesterday’s T-minus seven days piece, I discussed the latest general status of US polls heading into Election Day next Tuesday – still with a commanding lead for Biden, but with some tightening in evidence. Still, the general risk is that the polls actually look too optimistic for Republicans if there is strong voter turnout as it is widely believed there will be. And as I have noted elsewhere, the pollsters may have over-adjusted for unique factors in the 2016 voting patterns that are less relevant this time around. With those factors in mind, I will run down the different scenarios as I seem them on Election Day and how the US dollar and other asset may react. The action on Election Night and into the following days could prove highly volatile if the Senate outcome remains in doubt for an extended period.

Important for all scenarios below: These are my own personal opinions on the likely outcome and reactions and I keep a very open mind that will inevitably change as the situation develops. My lean for probabilities is far more in favour of a stronger Democratic outcome than many pollsters are showing, and do not reflect a “house view”. I think it is fair to assume a 0% probability of Democrats losing the House of Representatives, which they hold at 236-196 (with 3 vacancies).

Scenario 1: “Trump Squeaks By”  with a narrow margin, and Republicans retain a majority in Senate

Probability: <5%.

I really don’t want to spend time this scenario, as I consider it so unlikely. As I said yesterday, if Trump wins, we have to question why the polling industry even exists. As well, please reread the section in my post yesterday on the pattern of votes as early states roll in – risks are very different for different states and the “Red sunset/Blue dawn” scenario will only be the case for some swing states and the opposite will be the scenario for Florida and possibly North Carolina. So even on election night itself in the early hours, traders may not have a chance to indulge in thoughts that a Trump win is a possibility for any length of time.

If by some miracle, Trump does manage to pull this off, the Democrats will inevitably challenge the result bitterly in every swing state on recounts and accusations of voter suppression and we could even see a constitutional crisis as Trump would likely only win with another large national popular vote deficit. The risk of even civil unrest would be quite high. Markets may try to put a positive spin initially on Trump winning on avoiding Democratic agenda, but more likely we see ugly turbulence back and forth until the final result is clear.

Market reaction for a Trump Squeaks By

USD: the US dollar would like spike strongly higher by a couple of percent or slightly more as soon as the result is reasonably clear – mostly as an unwinding of the “Blue Wave” scenario that is already partly priced into market expectations before the election. But keep in mind that the Democratic opposition in the House is still there and would challenge Trump every step of the way on supply-side reform that he accomplished in his first two years. Net-net, the US dollar rally would likely quickly fade and the US dollar would fall broadly, particularly against reflationary commodity currencies and even EM.

Gold/commodities: A gold sell-off is short and sharp and recovers quickly as Big Spender Trump seen likely – he is no ideologue, and US-China friction concerns would be higher in this scenario. Commodities follow a similar course – less bullish for commodity complex than Blue Wave.

Risk appetite/equities: Strong at first, more neutral further out relative to other scenarios. More likely to support the status quo as Trump will be prevented from excessive “cash splash” style stimulus if these in any way isolate Democratic strongholds (blocked by the Dem House) and supply-side measures won’t pass Congress – at all.

Bonds: Not entirely sure in early phases – in general, would expect yields to eventually rise as Trump is no deficit hawk and would likely be happy to do almost any amount of spending that boosts his legacy and popularity with his base and likewise boosts the stock market. Less green agenda under Trump would likely mean lower inflation than otherwise, so rising yields may rise less than under Blue Wave scenario below

Scenario 2: The Train Wreck: Biden wins, but Democrats fail to take the Senate

Probability: <20%

This is “the train wreck” scenario for two reasons. First, it would likely come with a very bitterly contested election, as Trump and his administration move to block counting of mail-in votes amid charges of fraud, etc. Second, it would mean the risk of a “scorched earth” campaign by an obstructionist Republican Senate, which had a history under Obama in particular of blocking everything at all times, in hopes that the economy will be a mess for a Republican comeback in 2022.

Market reaction for The Train Wreck

USD: chaotic markets a likely risk and the US dollar could back up sharply to the strong side as the market finds the path to the expected massive Biden deficits blocked by the Republican Senate. Eventually USD weakens anyway, if at a far slower pace than the Blue Wave scenarios as US inflation will still be seen as more likely to rise more than elsewhere and that the Fed will do everything it can to make up for what fiscal is not bringing.

Gold/commodities: worst possible scenario for gold in the short to medium term, takes longer for path to new bull gold market. Commodities frustrated by stronger USD until that factor fades and as stimulus is choked off.

Risk appetite/equities: very ugly market volatility a prominent risk, but keeping existing tax structure in place generally leaves equities in a better place than they would be otherwise. The longer term would focus on how 2022 mid-terms would shape up politically as the Republican blocking approach could back-fire.

Bonds: initially a curve flattening response as growth would fare poorly under this scenario and a more aggressive Fed might look to keep longer yields lower with more aggressive YCC. Stagnation and boredom a strong risk.

Scenario 3: The Biden Base Case: Biden wins, with a very slim control of the Senate

Probability: 25%

In this scenario, the first higher odds scenario, Biden wins with a sizable popular mandate but barely gets the majority needed in the Senate (50-50 is enough, as VP Harris could cast deciding vote). The contested election scenario beyond a few days or a week is avoided, keeping the risk of aggravated market volatility at bay. The reasonably strong mandate – especially in the national popular vote -  allows Biden’s the leeway to bring strong new spending plans and some of his tax proposals to see the light of day, but worry-wart Democratic Senators worried about re-election in 2022 elections can make themselves very powerful by watering down key initiatives by threatening not to vote in favour.

Market Reaction to the Biden Base Case

USD: a more full-throated USD sell-off is slower to develop as the market is more tentative on whether Biden’s mandate is watered down and the centrists worried about the slim majority push back against the progressives.

Gold/commodities: watered down response, a weaker echo of the Blue Wave scenarios described below but in the end very supportive for both gold and commodities.

Risk/equities: less negative for growth stocks and risk than the full Blue Wave scenarios. Green agenda perhaps over-priced in equity market if this is the scenario.

Bonds: Yields to steepen, and enough stimulus arrives to drop unemployment more aggressively and keep the Fed from doing more than simply not reacting to rising inflation while happy that unemployment is dropping more quickly (important presumption is that exit path from Covid is shaping up before spring!)

Scenarios 4 and 5: The Blue Wave and the Blue Tsunami: Biden wins in a landslide.

Probability: 50%, (30% for Blue Wave, 20% for Blue Tsunami)

I roll these two scenarios into one because the reaction function would most likely not change much for quite some time after the election, but a likely key difference could develop over time between the Blue Wave versus the Blue Tsunami. For the sake of definition, the Blue Wave scenario is a 52-48 victory in the Senate together with perhaps an 8 point or more win in the national popular vote. A Blue Tsunami is a shocker that sees a more than 10 point in the election all of the close swing states going to the Democrats and their taking of Texas (last went Democratic in 1976) and Georgia. If those last two states go to the Democrats, we are likely talking about the most tilted electoral outcome since Bush senior won by with over 400 electoral votes in 1988.

The key difference is mostly one of magnitude – with a Tsunami meaning more stimulus, more legislation aimed at addressing inequality, healthcare and maybe even monopolies, and a far larger Green Agenda spending. In the longer run, the key difference is that a Blue Tsunami represents such a powerful rejection of what the Republican Party became under Trump, that the Democrats could even risk eventually indulging in a civil war, with the young progressive left claiming it was their support with the largest youth generation turnout that got the party’s 2020 result, and wanting to throw off the traditional, corrupt Washington elite and centrists.

Market Reaction to the Blue Wave and Blue Tsunami Scenarios

USD: as evidence of strong youth participation is clear, and with progressive voices clamoring for significant change, the USD weakens and does so sharply and persistently from the get-go, especially under a Blue Tsunami scenario. Stimulus is passed before the end of this year and trillions more is on the board for 2021 under a Blue Wave, with heavy aid for income replacement, health care and the Green Agenda (and hopefully small and medium businesses – the most important!). The US negative real rate story is supercharged and inflation ticks up aggressively, driving the USD well over 10% lower by mid-year.

Gold/commodities: the ideal scenario for both Gold and commodities, but something like silver perhaps even more so on its dual use as industrial and precious metal. Ironically, the Green Agenda supports oil prices considerably because of the choking off of investment for highly capital-intensive oil production. As the US produces so little of what it consumes, the heavy stimulus and weaker USD stimulate the world economy and add to the upside potential for commodities.

Risk appetite/equities: a very different agenda for equity traders than what we have come used to post-Covid19. Long duration will be avoided at all costs – and the market will demand a higher return on higher risk / growth stocks with cash flows so far off in the future. Value stocks to get a boost on their stronger earnings yield. And the biggest monopoly names could come under pressure as Democrats are far more likely to agree to a multilateral global taxation arrangement and more aggressive in looking to break up monopolistic behaviour.

Bonds: Hefty yield curve steepening until the Fed steps in to do yield curve control if the rise in yields is feared to prove disruptive enough to slow job market gains. Imagine a world in which inflation moves to 4-5%, nominal growth is 5-6% and the Fed is seen likely to only raise the policy rate to slowly raise the policy rate back to 1% and cap the longest yield at 3%. The question is whether The Fed could pull something off like this without exploding its balance sheet to swallow most of the entire universe of longer dated treasuries.

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