Markets Braced for Election and Rate Storm

As the midterm elections approach, investors are bracing for a volatile two weeks, with potential market shifts driven by both political uncertainty and central bank rate moves. This article explores the market dynamics at play during midterm election seasons and the impact of rate decisions on investor sentiment.

Historically, midterm elections have been associated with higher market volatility, as candidates draw attention to the country's problems and campaigns amplify negative messages. Since 1970, midterm years have a median standard deviation of returns of nearly 16%, compared with 13% in all other years. This increased volatility is particularly noticeable in the weeks leading up to Election Day.

The U.S. president's party typically loses seats in Congress during midterm elections, with an average loss of 28 seats in the House of Representatives and four in the Senate over the past 22 elections. This trend is usually priced into the markets early in the year, but the extent of the political power shift and its resulting policy impacts remain unclear until later in the year.

Market returns during midterm election years tend to be muted until later in the year, with a lackluster performance in the first several months. However, markets have tended to rally in the weeks before an election and continue to rise after the polls close. This pattern is evident in the average trajectory of equity returns throughout midterm election years compared to non-midterm election years.

The Federal Reserve is expected to make a rate decision in the coming weeks, which could further influence market sentiment. Investors are pricing in something like six quarter-point rate cuts from the Federal Reserve in 2024, indicating a high degree of uncertainty about the economic outlook. If inflation proves to be more persistent than expected, even a single data release suggesting a pick-up in inflation could trigger a violent market reaction.

As we navigate these two wild weeks, investors should remain vigilant and prepared for short-term volatility. While the election results may not be the primary driver of investment outcomes, the combination of political uncertainty and rate moves could lead to market fluctuations. By staying informed and maintaining a long-term perspective, investors can better navigate the potential challenges ahead.

In conclusion, the upcoming midterm elections and central bank rate decisions are likely to create a volatile two weeks for investors. By understanding the historical market dynamics during midterm elections and the impact of rate moves on investor sentiment, investors can better position themselves to weather the storm.