How Will US Midterm Elections Affect Forex Markets?

Markets are in wait-and-see mode going into the US Midterm elections. This time around, the elections could have a more significant impact on forex, as traders mull the potential geopolitical implications. Many strategists believe that the Fed factored in the election when timing its rate hikes, not wanting to appear to make changes in the lead-up to the people heading to the polls.

The outcome of the vote is likely to be a factor, but analysts also say there will likely be market-moving changes in the geopolitical situation regardless of the election results. Here are some of the factors that investors will be looking at as the vote counting gets underway on Tuesday evening:

A Bump in Crude, Dollar on Middle East?

The White House has played down the conflict with Iran in the weeks ahead of the midterms, as military action is seen as increasingly unpopular with the American public. Iran’s attempts to throttle crude shipments through the Strait of Hormuz have raised fuel prices and could be seen as a bargaining chip with Washington. Once the US Midterm Elections are over, that leverage is substantially reduced.

US forces have been building up in the region despite US President Donald Trump saying he does not plan to use ground troops against Iran. The Wall Street Journal reported on Monday that the US launched strikes against Qeshem Island, seen as a major base for Iranian attacks on shipping. Even if Democrats win a sweeping victory, they don’t take office until next January, which allows Trump plenty of room to step up attacks. And Democrats are likely to prioritise other issues even if they get control of Congress. The flip side is that under the new scenario, Iran could be more willing to offer concessions and end the war.

The Three Potential Electoral Outcomes

There are three likely outcomes for the US Midterm Elections, each with different potential impacts on Forex. The most likely is a divided government, with control of the Senate as key. Polling suggests Democrats are likely to win the House of Representatives, which would allow them to restrict new aggressive fiscal policies and/or any major tax changes. But without control of the White House, they will be unable to actually pass any major legislation. This would shift the market’s attention back to economic data and Fed policy, likely to be slightly bearish for the dollar and gold, but positive for the Euro, Pound and Yen.

Like in 2018, a Trump presidency with a Democratic Congress will likely mean Democrats will focus on trying to get an impeachment. But, without a majority in the Senate, the impeachment will likely have no impact. If Republicans maintain control of the Senate, the status quo would likely remain, allowing for a more modest reaction in the markets. If the Democrats take control of the Senate, they’d have more options to impede Trump’s policies, such as holding up Judicial appointments. This would likely heighten political turmoil in Washington and weigh more on the dollar.

Potential Surprises that Could Move the Market

Polling suggests it’s unlikely, but a third possibility is that Republicans manage to hold the Senate and House, which would preserve the current political situation. It would pave the way for more stimulus, tax adjustments and budget expansion. Yields would likely rise as investors worry about rising debt, but it would also likely support the dollar and gold prices. The yen and Swiss franc could be more vulnerable to this scenario, given the yield differentials. Commodity currencies could have differing reactions, with the AUD likely under pressure amid a more aggressive policy stance toward China, while higher crude prices are likely to support the CAD.