Market Reactions to Potential Republican Control

By Saqib Iqbal Ahmed

NEW YORK (Reuters) – Investors are increasingly factoring in what potential Republican control of government could mean for stocks, bonds, and currencies, even as the initial market reactions to Donald Trump’s presidential victory begin to settle.

A so-called red sweep scenario, in which Republicans control the White House and both houses of Congress, could pave the way for Trump to implement his economic proposals with greater freedom. Many of these proposals, such as tax cuts, are perceived as growth-friendly but may also increase inflation risks.

As of Friday, Republicans held a narrow edge while election officials continued to tally votes determining control of the U.S. House of Representatives, although Democrats succeeded in flipping two New York state seats.

"With many of Trump's policies geared to support stocks, particularly small caps, markets are likely to respond well to a red sweep," said JJ Kinahan, CEO of IG North America and president of online broker Tastytrade.

Expectations that Trump's policies will be enacted have helped lift parts of the stock market, boosted the dollar, and pressured Treasuries, as investors adjusted portfolios for stronger growth, looser regulations, and potential inflation concerns affecting Federal Reserve rate cuts next year.

One notable movement is in small-cap stocks, with the Russell 2000 index up about 8% this week.

While some of these gains have slowed recently, investors are still considering how Trump’s policies might impact markets and the economy over time, especially under a red sweep scenario.

Trump has committed to eliminating federal regulations he argues hinder job creation. He intends to maintain a 2017 tax cut he signed into law and has proposed further individual and corporate tax cuts beyond those from his first term.

Strategists at Goldman Sachs suggested that their earnings per share estimates for the S&P 500 would increase by around 4% if Trump lowered the statutory domestic corporate tax from 21% to 15%.

Deutsche Bank analysts indicated they would raise their 2025 U.S. growth projection to 2.5-2.75% from 2.2% in the case of a red sweep, although they expect to reduce their 2026 growth prediction due to anticipated economic uncertainty from an escalating trade war.

Republican control of government might also give a long-term boost to the dollar, which has reached its highest level in four months against a basket of peers following this week’s post-election spike.

JP Morgan strategists predict the euro might fall to $1.00-$1.02, down about 6% from its current level, with a unified Republican government, instead of declining to $1.05 under a divided Congress.

Historically, strong stock performance has been linked to unified government control. The S&P 500 has risen by an average of 9.1% during such periods, compared to a 6.7% average annual return for divided government since 1928, according to Evercore ISI analysis. The index reached 6,000 points for the first time ever on Friday, reflecting a 26% rise this year.

However, some investors believe that even with a Republican Congressional majority, the narrow margin in both the House and Senate could still pose challenges to implementing significant fiscal and regulatory changes.

"We may not get everything that has been promised. The discussion on the campaign trail is always very different from what legislation gets passed," said Paul Nolte, senior wealth advisor and market strategist for Murphy & Sylvest. "I think a lot of that is already reflected in stock prices today."