There are three possible scenarios for tomorrow's election.
The first scenario: for some unexpected reason, Republicans retain control of Congress. Objectively speaking, this would be a massive surprise and the most tradeable of the three scenarios. Markets would read it as a positive growth surprise, pushing the S&P 500 Index and the US dollar higher, similar to the moves after Donald Trump's surprise 2016 victory and the Republicans' sweeping win in 2024.
The second scenario: Democrats take the House while Republicans keep the Senate. I believe this is the base case for most people, and almost no capital would be positioned to trade around this outcome.
The third scenario: Democrats sweep both chambers, representing the most thorough rejection of Trump. Some would argue this is the most bullish for markets because it would constrain Trump to the greatest extent, but I think that view misunderstands what markets truly care about.
After all, markets have frequently gone long on markets like China and Turkey that lack Western-style democratic checks and balances. What markets value is returns 鈥?that is, economic growth 鈥?not idealized notions of democracy.
If you doubt this, just think back to this time last year, when everyone was convinced the US dollar was losing its status as the global reserve currency. That did not happen, and the reason is that markets do not care about institutional constraints on figures like Trump; markets care only about growth.
Even setting all of that aside, there are two fundamental reasons why tomorrow's midterm elections are unlikely to rattle markets.
First, no matter the election outcome, it will be overshadowed by whether the US resumes bombing Iran. I have written about how markets would react once a "hot war" breaks out. Unfortunately, the risk of war would completely drown out the impact of the election results.
Second, even without the external distraction of war, midterm elections themselves typically do not trigger major market swings. This article reviewed the situation in 2022: at the time, markets widely expected a "red wave" (a big Republican win), which did not materialize 鈥?a major surprise 鈥?yet markets did not care at all and completely ignored the midterms. I judge that the current market will repeat this pattern.
Looking at the charts showing the S&P 500 Index (top right), the US dollar against a G10 basket of currencies (bottom left), and the US dollar against emerging market currencies (bottom right). The blue line represents the current 2026 trajectory, while the black line represents the trajectory around the November 8, 2022 midterms, when markets widely anticipated a "red wave." Both years' data are benchmarked to the day before the war broke out and indexed to 100; the 2022 benchmark is February 23, when the Russia-Ukraine war began, and the 2026 benchmark is February 27, when the US and Israel bombed Iran. The orange diamond marker indicates November 9, 2022, after the midterms ended. The charts clearly show that markets did not produce any corresponding move in response to the surprise failure of the "red wave." The dollar weakened and the S&P 500 rose in late 2022 because the Federal Reserve stopped its aggressive 75-basis-point rate hikes, signaling a slower pace of monetary tightening.
(Chart caption: the four charts below show the 30-day forward implied volatility for crude oil (top left), the S&P 500 (top right), the bond market (bottom left), and high-yield corporate debt (bottom right). They are likewise indexed to 100 based on the day before the war broke out: February 23, 2022 for the Russia-Ukraine war, and February 27, 2026 for the US-Iran conflict. The orange diamond again marks November 9, 2022, once more proving that the options market showed no significant volatility.)
There are two major reasons markets will not trade around the midterm elections. The first and most important: the massive event risk of a possible renewed hot war with Iran. With such a risk hanging overhead, almost no trader would trade the midterms. The second reason: even if the external environment were calm, the midterms themselves would struggle to drive markets. 2022 is a good example 鈥?that year's Republican "red wave" did not arrive, a genuine above-expectations event, yet markets remained unmoved.
Comments