The three big election scenarios, and the one that scares Wall Street the most

A big blue wave is what Democrats are hoping most for, but it spells the only apparent danger scenario for investors coming out of Tuesday’s midterms.

If all goes according to forecast, the Democrats will capture the 23 seats and then some that they need to flip the House of Representatives in their favor, while the Republicans will be able to stave off the challenge and hold the Senate, perhaps even building slightly on the current 51-49 GOP margin.

One dark horse looms, though: A Democratic sweep that includes the Senate and sets the party on a collision course with Republican President Donald Trump.

While unlikely — forecaster Nate Silver at FiveThirtyEight gives it just a 19.1 percent chance of happening — the result would be the most likely to upset Wall Street, which is coming off a brutally volatile month.

“Headline risk [is[ exponentially bigger” under the Democrat rout scenario, wrote Chris Krueger, Washington strategist for investment bank Cowen’s Washington Research Group. The Republican “deregulatory agenda will come under pressure as the Senate will shut down new Executive Branch confirmations and judges will come to a nuclear freeze.” Chances of impeachment in the House also increase, though conviction in the Senate would remain unlikely, he added.

While Krueger concedes that this is “the most most unlikely of the election scenarios,” it is also “likely the most market negative in the near-term.”

Should the Democrats take full government control since the first two years of former President Barack Obama’s first term, the possibility increases that someone like Vermont Sen. Bernie Sanders could become president, he added. A hard-left president would bring “the Herbal Tea Party’s greatest hits like Medicare for All, ‘Free’ College, tax hikes, regulation, trading/bank tax, etc,” wrote Kreuger.

The other two scenarios are a little less complicated.

The baseline from pretty much everyone on Wall Street is the aforementioned House-Senate split and the accompanying expectations of at least some level of gridlock.

“Our suspicion is that there will be limited bipartisanship that will extend only to things like the debt ceiling, sequester relief, and other ‘must pass’ bills,” Krueger said. “The Venn Diagram of potential areas of compromise includes everything from infrastructure and drug pricing, to a federal minimum wage hike and student debt relief.”

One other big area of cooperation could be on trade, where Krueger expects most Democrats to stay in line with Trump’s get-tough policy on China.

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