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Blue Wave Washes Over Currency Markets, Then Recedes

Karl Schamotta January 6, 2021

A number of major media outlets have called the Senate runoff race in Georgia for Jon Ossoff – handing control of the Presidency and both houses of Congress to the Democratic Party. Ossoff toppled incumbent Republican David Perdue, joining Reverend Raphael Warnock – who defeated Kelly Loeffler earlier in the day – in shifting the balance of power in the Senate. Theoretically, the Biden administration – with Vice President Kamala Harris’ tiebreaker vote – will now have the capacity to smoothly approve presidential nominations and pass major pieces of legislation along party lines.

As the race was framed by pundits, an unfettered Democratic Party might now feel empowered to boost fiscal spending and infrastructure investment, raise taxes on corporations and wealthy Americans, and tighten regulation in the finance and technology sectors. Under this regime, markets expect an acceleration in growth, higher fiscal borrowing requirements, and upward pressure on inflation rates.

But two factors complicate this picture:

With only 50 seats, the Democrats still fall far short of the 60-vote filibuster-proof majority needed to pass most types of legislation. Republicans (and moderate Democrats) will retain a significant amount of bargaining power – meaning that this is hardly the “blue wave” scenario that some had hoped for ahead of the November election.

And the US Capitol has come under siege, occupied by a large group of Trump supporters who – after having whipped into a fury over a period of years – were exhorted into violent action by Republican Congressmen and campaign officials at a series of “Stop the Steal” rallies this morning. Lawmakers from both parties are locked down in the building, police officers are battling rioters throughout the complex, and the National Guard has reportedly been activated. The chaos is being broadcast across global television networks, causing dismay (and delight) in many foreign capitals.

This is likely to put more pressure on the Republican Party, exacerbating already-extreme divisions within the ranks. Power could be transferred from establishment figures like Mitch McConnell and Lindsay Graham to moderates like Mitt Romney – or the party could splinter into a number of warring factions. The impact on policy in the months ahead is impossible to predict, with Joe Biden potentially finding willing partners to work with across the aisle – or bitter enemies.

Against this backdrop, exchange rates are reacting with remarkable aplomb. The yield curve is only slightly steeper as we go to pixels, and the dollar remains largely unchanged against its major counterparts. Risk sentiment seems to have weakened modestly, but no sharp adjustments have yet become visible.

To us, this suggests that markets expect the political system to descend into gridlock, with no one able to gain the commanding heights, and Congress effectively sidelined. This might seem less than ideal (and will likely keep the noise emanating from Washington at deafening levels), but it is what the founders intended. When leaders are forced to achieve bipartisan consensus, extreme policy transitions are more difficult to implement, and potentially catastrophic imbalances are dramatically reduced. Errors tend to cancel themselves out, leaving the economy untouched.

After all, if today teaches us anything, it’s that there’s wisdom in something Mark Twain once said – “Reader, suppose you were an idiot. And suppose you were a member of Congress. But I repeat myself”.
Karl Schamotta
Chief Market Strategist