Chance of Republican Clean Sweep High
6th November, 10:53
The likelihood of a Republican clean sweep is significant. While it remains to be seen to what extent Trump will follow through on his economic policy promises or if this is a starting point for negotiations, we’ll have to wait and see.
Markets are positioning themselves for higher import tariffs and lower taxes, which could positively impact corporate profits, economic growth, and inflationary pressure in the U.S. This scenario means that, after a likely rate cut this week, the Fed will tread carefully with further rate reductions. However, markets are increasingly concerned about the sustainability of government finances, with the U.S. yield curve steepening significantly due to long-term rates rising faster than short-term rates. In other words, the term premium on long-term government securities is rising sharply.
In Europe, a potential Republican clean sweep is seen as negative for economic growth (due to higher U.S. import tariffs), which may give the ECB more room to lower rates. Yield curves in many European countries are steepening as well, but this is caused by 2-year yields falling faster than those on longer maturities. Lower oil prices and EUR/USD movements reinforce this picture, as energy import inflation is expected to decrease.
The rise in European stocks could be explained by expectations of a more accommodative ECB policy, a stronger dollar, and the hope that higher U.S. growth will offset the negative impact of increased tariffs.
Precious metals are declining, likely due to a stronger dollar and higher real interest rates, with investors seemingly anticipating that Bitcoin might become a more attractive safe haven under Trump than gold.
In the coming weeks, a sustained “Trump trade” (stronger dollar, rising stocks, and higher interest rates) is likely. However, several developments could limit EUR/USD's remaining downside potential:
- Further increases in U.S. long-term rates could make Congress hesitant to expand fiscal policy significantly.
- China may be prompted to stimulate its economy further, which would benefit Europe more than the U.S.
- A further decline in oil prices would support EUR/USD, as Europe is a major oil importer.
- A new term for Trump could encourage European countries to take additional measures to stimulate their own economies and foster closer cooperation within governments, especially in Germany and France.
Should a combination of these factors materialize, the decline in EUR/USD could be limited to 1.045. If not, and a Republican clean sweep occurs, parity or lower is likely.
At the same time, the upward potential for US stock prices appears to be limited as well. Besides very high valuations of US stocks, a further increase in real long-term rates will become increasingly detrimental to the bullish case for US stocks. Higher real rates lower the current value of future profits, and it could make borrowing costs prohibitively high, resulting in less appetite of consumers and – ultimately – the government to increase borrowing and spending.
In the coming weeks tot months rising (real) long-term rates will likely be accompanied by rising stock prices, as both prices will reflect higher growth expectations for the US economy in case the Republicans will accomplish a clean sweep. However, once the 10-yr US Treasury yield rises to 5% or above, we expect the negative effects of higher real rates will weigh more heavily on stocks prices and the economy, resulting in the start of a bear market next year. In the meantime, the S&P 500 index could increase further to 6000 – 6200.
In case of a Republican clean sweep, the short-term outlook for EM stocks is quite negative due to the stronger dollar and higher real rates, which will result in more concerns on debt sustainability in EM economies and will encourage capital to flow to the US.
European stocks will likely fare better than EM stocks but will likely underperform US stocks in the coming weeks due to the negative effect of higher US import tariffs on European companies.
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