As widely anticipated, the Democrats will regain control of both the House and the Senate following the US mid-term elections, winning clear majorities in both chambers. The only real surprise was the extent of the margin of victory.
In a nutshell, a Democratic sweep reduces the risk of further large-scale fiscal expansion but increases the risk of budgetary confrontation, investigations and unilateral executive policymaking. President Trump retains substantial authority over trade, immigration and foreign policy.
According to perceived wisdom and AI, a gridlocked government (Democrats controlling Congress and a Republican President) is bullish for Treasuries, negative for the USD and positive for equities. That has been precisely the market reaction, although as the results were coming in yesterday, US equity futures initially tumbled before reversing. One key concern is that increased Democratic power could act as a brake on the progress of AI and the building of data centres. Furthermore, if the Democrats win the Presidential race in two years, they will be able to push through major policy changes, such as higher taxes, many of which would be unlikely to be perceived as market-friendly. That is a risk the market isn’t willing to price today, but it is something to think about further down the track.
President Trump told the FT he has no immediate plans to launch strikes on Iran following the mid-term elections. VP Vance said, “the reason we lost is the war”. A Democratic Congress cannot block Trump’s foreign policy but has leverage through its control of war funding. Iran’s parliament speaker said the election result showed that Americans have voted “NO TO WAR”. Oil prices fell steadily overnight, culminating in a 10% tumble for Brent crude that took the price around USD93 per barrel.
The combination of the US election result and lower oil prices has pushed US Treasury yields lower across the curve. The 10-year rate is currently 4.89%, down 7bps for the day, although much of the fall occurred during NZ trading hours. There was little further progress overnight, and the session has been choppy, with a temporary reversal to as high as 4.96%. The US Treasury tweaked its guidance on debt issuance, maintaining nominal coupon and floating rate note auction sizes for the next several quarters but dropping the prefix “at least” before “several quarters”. This raises the possibility of reduced issuance of long-dated debt and higher sales of short-term securities.
European yields have fallen substantially. Germany’s 10-year rate is down 6bps, but the falls have been much larger for France, the peripheral markets and the UK. This largely reflects higher risk sentiment and bond markets being supported by the chunky fall in oil and gas prices. France’s 10-year rate fell 17bps, while the UK’s 10-year rate fell 13bps.
US ADP private payrolls rose 86k in October, above the 67k consensus, following a solid gain in September. The key non-farm payrolls report is due at the end of the week. The ISM services index slipped a little to 54.5, while the prices paid index slipped a point to 73.0, remaining well above average.
Euro area CPI inflation data were in line with consensus, with the annual headline rate rising two-tenths to 4.0% and the core rate steady at 2.5%. The data had little impact on near-term policy expectations, with another hike in December remaining well priced at +21bps. Sweden’s Riksbank added to the number of central banks in a tightening cycle, kicking off the process with a well-anticipated 25bps hike and a bias to tighten further.
After S&P500 futures were down as much as 1.4%, US equities staged a significant rebound, and the cash index shows a gain of 1.8% in early afternoon trading. There has been wide dispersion in returns as the market absorbs the implications of the election result. Elon Musk-related companies SpaceX and Tesla are down around 3%, while big tech stocks have posted strong gains, with Apple, Amazon and Microsoft currently up 6-7%.
In the currency market, the USD is broadly weaker, with the fall in oil prices, higher risk sentiment and the mid-term election result all contributing. USD indices are down about 0.4% for the day. In overnight moves, the NZD and AUD have shown the strongest gains, reflecting higher risk sentiment. NZD/USD fell about 30pips to just above 0.5580 following softer NZ labour market data (see below), but the recovery in risk appetite has seen it trade as high as 0.5645 overnight. It currently sits at 0.5630.
The AUD has recovered to 0.7020. The weaker NZD/AUD cross that followed the labour market data has largely been sustained, with the cross at around 0.8020. The stronger risk backdrop has seen other NZD crosses recover from their post-labour market data losses.
NZ labour market data were weaker than expected, with a surprising 0.1% fall in employment in Q3 alongside downward revisions. Annual growth of 0.7% fell well short of the consensus estimate of 1.6%. The outcome defied a number of leading indicators that showed improved employment growth. Weaker employment fed through into the unemployment rate, which surprisingly ticked higher to 5.7%, a fresh cycle high. Wage data were mixed, with some indicators showing weaker annual inflation and others showing flat to slightly higher annual wage inflation.
The data complicated the monetary policy outlook. The dovish take is that extra labour market slack suggests less need for tighter policy. The hawkish take is that if core inflation is already rising and is at 3%, what will happen to inflation as the recovery gains traction and the unemployment rate begins to fall? The labour market isn’t contributing to higher underlying inflation but could easily do so once higher inflation expectations (notably cost of living adjustments) begin to feed through.
The market took on board the dovish interpretation, sending rates lower, driven by the short end of the curve, with global forces working in the same direction for mid to longer-term rates. At the close, the 2-year swap rate was down a chunky 13bps for the day to 3.75%, a fresh eight-week low. The 5-year and 10-year swap rates fell by 12bps and 9bps respectively. The swaps market outperformed NZGBs, which showed more moderate falls across the curve. The market still sees more chance than not of the RBNZ hiking by 25bps in December, but pricing for the meeting pared 5bps to +15bps, implying a slower pace of tightening through 2027.
On the event calendar, the Bank of England meets tonight and is widely expected to hike rates for the first time this cycle, lifting its policy rate by 25bps to 4.0%. Ahead of that, RBA Deputy Governor Hauser will speak tonight. The economic calendar is light, with US productivity data of some interest.
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Jason Wong is the senior Markets Strategist at BNZ Markets.
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