The first U.S. presidential debate ended yesterday, and voters (but also the rest of the world) had the chance to hear answers to both U.S. internal and external problems. For financial market participants, the aim is to prepare the investment portfolio in such a way to protect it from unexpected market shifts.
With this goal in mind, here are a few scenarios and a probable impact on financial markets and the Fed in case each candidate wins. Also, who wins the two chambers of Congress – Republicans or Democrats, or will we have a divided Congress? What happens in this case?
Scenarios for the USD and the Fed
The first thing to consider is Trump’s continuation at the White House. Not because the polls give him favorite (they do not), but because he is the acting President. In fact, prior to yesterday’s debate, the probability for Trump winning the White House again and of a divided Congress was around 30%.
In this case, the markets expect a higher USD policy. Despite the fact that Trump advocated for a lower USD all his term so far, a second term always differs from the first one as the President knows it is the last term in power, and some harsh measures (unpopular) are likely. Under such a scenario, the EURUSD should move lower, and the yield curve could steepen, albeit modestly.
A second scenario considers a Biden win and still a divided Congress. A Biden win is viewed as dovish for the USD. The market expects infrastructure investments, investments in education – all of which need funding. Hence, a lower USD and a higher EURUSD are the consensus under this scenario, with a probability of around 20% prior to yesterday’s debate.
The biggest probability of about 40% leads to a Biden win, and the Democrats take both chambers of Congress. This is the most dovish scenario for the USD, with EURUSD likely to experience a huge move higher. Moreover, the Fed is poised to keep the rates low for a long time under such a scenario. Combined with a new fiscal stimulus package expected from Democrats, the USD should tank.
Before jumping to any conclusion, note that such scenarios are common prior to any important election. But it does not mean the market will react like this, nor that it will react in an instant.
In 2016, the consensus prior to the election was that the stock market would collapse if Trump wins. Trump won, the stock market tanked for a few hours and then staged a massive reversal.
No one should be surprised if something similar happens in 2020 as well.