U.S. MIDTERM ELECTIONS

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1 WHAT DO THE U.S. MIDTERM ELECTIONS MEAN FOR THE DOLLAR AND STOCKS? THE FOREX.COM RESEARCH TEAM SPECIAL REPORT Foreign Exchange and other leveraged products involve significant risk of loss and are not suitable for all investors. Increasing leverage increases risk. Before deciding to trade foreign exchange and other leveraged products, you should carefully consider your financial objectives, level of experience and risk appetite. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. Contracts for Difference (CFDs) and spot commodities are not available to US residents. The charts, data, information, reference to any events or trends and opinions in this report are for general information use or illustrative purposes only and are not intended as an offer or solicitation to any product offered. There is no guarantee that any event or trend is likely to be repeated or that profits will be or are likely to be achieved. FOREX.com is not rendering investment, legal, or tax advice. You should consult with appropriate counsel or other advisors on all these matters. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions. All information and opinions contained in this report are subject to change without notice.

2 At the end of November, Americans will gather to celebrate the Thanksgiving holiday in commemoration of the Pilgrim s harvest feast celebration back in As many Americans know, there s an unspoken rule that you should never discuss three topics at the Thanksgiving table: money, religion and politics. Initially innocent discussions on these subjects often devolve into contentious arguments and have ruined countless family gatherings across the country. Thankfully it s not yet Thanksgiving, because this guide focuses on the intersection of politics and money, two of the forbidden topics mentioned above. U.S. Midterm Elections: Elephantiasis of the Ego Who s ready to vote?! That muffled murmur you hear is the 40% of Americans who typically actually go out to vote during the midterm elections, and even that proportion may be too generous this time around. Pundits from around the nation are expecting turnout to be uncharacteristically low due to the fact that, as politician John McCain puts it, people don t like Republicans, and they don t like Obama. While he could have stuck with the truism that most people just don t like politicians, he has a point. If you take a look at opinion polls by Gallup, President Obama has been hovering around a 40% approval rating, while Congress as a whole has been languishing at less than 25% approval since at least Regardless of the public s lack of interest rocking the vote, the results of these elections will have a far-reaching impact for at least the next couple years. As it stands now, the Republicans may have the upper hand with polls pointing toward an all-but-assured victory in the House of Representatives (see map below), but the biggest development from these elections would be if the Republicans can wrest control of the Senate from the incumbent Democrats. If the Republican Party is able to capture a majority in both houses of Congress, they will be able to control the process of making laws, though President Obama will still be able to veto laws that are unable to achieve a two-thirds majority. Don t forget that you can now follow Forex.com s research team on Twitter: twitter.com/forexcom 2

3 Projected House of Representatives Party Map: Source: Since the Senate is the more intriguing of the two situations, let s take a closer look. Senate Majority and the Debt Ceiling Heading into the election, the Democrats hold the majority in the Senate with a 53-to-45 lead over the Republicans (two senators are nominally Independent, but usually side with the Democrats). This arrangement has given the Democrats tremendous power over the political process over the last few years, in direct opposition to the power the Republicans hold in the House of Representatives. One of the peculiar arrangements of the Senate is that the terms are six years as opposed to two years for the House, and therefore only about one third of the seats are up for a vote every two years. This year there are 36 seats up for grabs: 21 Democrats and 15 Republicans. As we go to press, many of the statisticians who make a living forecasting elections are giving the Republicans a 60%-65% chance of gaining the majority in the Senate, which would give them control of both houses of Congress. This could have major implications for everything from Obamacare to welfare spending; but, crucially for traders, a Republican majority in the Senate could mean that there won t be another debt ceiling debacle like we had a few years ago. Don t go celebrating quite yet, though, because the lack of a debt ceiling debate means that the Grand Old Party could make cuts to government spending, which may be another blow to the economy that will be just getting used to life without quantitative easing. If the Republicans manage to secure a majority, the party s collective ego could become bloated, or in political parlance, they may take a resounding win as a mandate to pursue their agenda. Republicans could see their newfound strength as a message from the public that the spendthrift ways of the Democrats need to end, and they could get aggressive with that stance, particularly if ultra-conservative Tea Party candidates exert their influence. Unfortunately, a simultaneous contraction in monetary (from the Fed s taper of QE) and fiscal policy (if Republicans make cuts to government spending) could bode ill for the U.S. equity market and, by proxy, the U.S. dollar. 3

4 U.S. Midterm Elections: U.S. Dollar Impact Like everything else related to politics in the U.S. these days, the interaction between elections and markets is highly contentious and of questionable merit. Focusing in on the U.S. dollar, the results of this year s midterms are particularly uncertain. Will Republicans win control of the Senate? If they do, will they opt for an obstructionist or more conciliatory stance? How would either affect the U.S. dollar? Will the elections have any impact on Federal Reserve policy moving forward? These are just a few of the questions that traders will have to weigh in the wake of next week s elections. Current polls suggest that the Republican Party is slightly more likely to win a majority in the Senate, though the results are far too close to call for now. In our opinion, a Republican win may be a short-term negative for the U.S. dollar, as it would introduce additional uncertainty in the U.S. political picture and would likely preclude any major fiscal stimulus in the next two years. On the other hand, if the Democrats are able to retain control of the Senate, the U.S. dollar may benefit on the extension of the status quo, which has been dollar-bullish over the last two years. Of course, these predictions may be proven incorrect, so it s worthwhile to see what the charts suggest. Technical View: U.S. Dollar History never repeats itself but it does rhyme is a quote often attributed to Mark Twain, though like many of his quotes, there is no conclusive evidence that the famous author ever wrote these words. Regardless, the U.S. dollar s price action around past U.S. elections may provide a guide for what to expect from the buck moving forward. As the long-term EURUSD chart below shows, the greenback has shown a tendency to strengthen (shown by a falling EURUSD in the chart) in the year running up to a U.S. Congressional election and weaken (shown by a rising EURUSD) in the year following the election, regardless of which party wins. If this pattern repeats, it suggests that the dollar may actually pull back after the election: Source: FOREX.com 4

5 That said, the relatively hawkish stance of the Federal Reserve, in contrast to the easing biases at most other central banks, suggests that any weakness in the buck may be short lived. Indeed, the widely followed U.S. dollar index recently broke out to a new four-year high above 85.00, suggesting that the bulls are currently in control of the market. Though the index has pulled back the last couple of weeks, the weekly RSI was deeply overbought at its peak in early October, suggesting that the recent dip may have simply been profit-taking on the part of bulls, rather than a change in the medium-term trend. Meanwhile, the weekly MACD indicator continues to trend higher above both its signal line and the 0 level, showing strongly bullish momentum. Source: FOREX.com As long as the dollar index is able to hold above previous-resistance-turned-support in the zone, higher prices will be favored for the world s reserve currency. In this situation, the EURUSD may target to its recent low at , GBPUSD may drop toward , and USDJPY could rally back toward or On the other hand, if the dollar index breaks that key support zone, EURUSD may extend its recent bounce toward 1.30, GBPUSD could rally to , and USDJPY may drop back to its recent floor at Regardless of what happens in the upcoming midterm election, the massive, broad-based uptrend we saw in the third quarter of this year is likely to moderate in the coming weeks and months. Therefore, traders are encouraged to be more selective with their USD-based trades moving forward. 5

6 U.S. Midterm Elections: The S&P 500 Of course, the outcome of the midterm elections will also have an impact on the direction of the U.S. stock markets, especially if it gives rise to uncertainty. The Republicans are often deemed business friendly which, in theory, should be good news for stocks, but this hasn t been the case recently. Indeed, under President Obama s leadership, the S&P 500 has made significant gains since he took office just before the stock market bottomed in 2009, though it would be foolish to suggest he or his Democratic party were the main catalyst behind the rally. Nevertheless, if the Democrats are able to retain control of the Senate, this could be good news for equities, all other things being equal. On the other hand, a Republican win may increase political uncertainty in the U.S., which is typically a headwind for stocks. Regardless of which party wins control of the Senate, we cannot ignore the impact of the other factors that are currently affecting the markets in particular, the uncertainty over the future of U.S. monetary policy. At the conclusion of the October 29 meeting (which will not be published until after this report is published), the Federal Reserve is widely expected to end its asset purchases program. This would remove what many analysts consider to have been a major source of support behind the stock market rally over the past few years. In the absence of QE, with increased political uncertainty that could arise from the midterm elections and the potential outbreak of Ebola, among other things, it will be interesting to see whether the markets will be able to reach fresh record-highs again. That said, interest rates will likely remain low well into 2015, and this could help support the markets and limit the downside risks. On top of this, the third-quarter earnings season has so far been solid and if the trend continues then the markets could extend their gains. Traders should watch the technical levels closely as the political and fundamental events unfold over the coming weeks. Had the S&P s correction that began in September not ended around the key 1820 level, we may well have seen further follow-up technical selling, which could have completely changed the psyche of the market. As well as horizontal support, the 1820 level corresponds with the lower trend line of the long-term bullish channel that has been in place since 2011 (see the weekly chart below). Going forward, unless the index breaks out of the channel, we are likely to see a continuation of the long-term bullish trend. Having said that, this latest correction has been among the worst in recent times, which may have scared away many market participants. What s more, the weekly RSI has broken its bullish trend after creating multiple negative divergences. What this means is that the bullish momentum has been fading and there is a chance that the markets may have already peaked, which is why it is extremely important to watch the near-term technical levels closely for signs of resistance, especially around this time of heightened political uncertainty. As can be seen on the daily chart, the S&P has already broken above the 61.8% Fibonacci retracement level of its move down from the September peak, so there is a good chance it will at least reach the 78.6% retracement at 1978/9 soon. On the way to that level lies the 50-day moving average at 1967/8, which could also provide some resistance. It is also worth watching the psychological 2000 barrier and the September peak itself,at 2022, for signs of resistance. Beyond these levels, there are two Fibonacci extension points which need some close attention. The first one can be seen on the daily, while the second one is visible on the weekly chart; they are the 127.2% and 161.8% extension levels of the corrections from September 2014 and October 2007, respectively. They represent exhaustion points for the index, so should we get there, expect to see some profit-taking at the very least. But these are among our longer term bullish targets. In the short term, if the S&P does run into resistance around any of the abovementioned levels, then a break below the first key support could signal the start of another leg lower. At the time of this writing, 1930 seems to be a pivotal level which, if broken, could see the index drop towards the 200-day moving average at 1909/10 and then the key support at A daily close below 1900 would be a very bearish outcome as that would clear the way for a revisit of 1820, and in the process a potential breakdown of the long-term bullish channel. 6

7 Source: FOREX.com. Please note this product is not available to U.S. clients. 7

8 Source: FOREX.com. Please note this product is not available to U.S. clients. Foreign Exchange and other leveraged products involve significant risk of loss and are not suitable for all investors. Increasing leverage increases risk. Before deciding to trade foreign exchange and other leveraged products, you should carefully consider your financial objectives, level of experience and risk appetite. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. Contracts for Difference (CFDs) and spot commodities are not available to US residents. The charts, data, information, reference to any events or trends and opinions in this report are for general information use or illustrative purposes only and are not intended as an offer or solicitation to any product offered. There is no guarantee that any event or trend is likely to be repeated or that profits will be or are likely to be achieved. FOREX.com is not rendering investment, legal, or tax advice. You should consult with appropriate counsel or other advisors on all these matters. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions. All information and opinions contained in this report are subject to change without notice. 8