The election results eliminated several major risks to markets

The outcome of the U.S. midterm elections panned out as most analysts expected, with Democrats taking control of the House, and Republicans retaining the Senate. As a result, markets were mostly unperturbed.

While the in-line results kept volatility in check, two other outcomes could also have materialized, which would have posed more significant implications for capital markets. A so-called “Blue Tsunami,” with Democrats taking the House and Senate was considered a fluke.

But a “Red Wall” – with Republicans keeping the majority in both chambers – was a solid possibility in the lead-up to elections. And many investors believed that a Republican sweep would have been risk positive for equity markets, leading to a more aggressive pursuit of fiscal stimulus and tax cuts going into the 2020 presidential election. Goldman Sachs economists anticipated that a Republican Congress would have pushed through a second round of tax cuts translating into a boost of about 0.3% of GDP in 2019.

That sounds like good news for the economy. However, such a plan would likely have been financed by deficits, which would, in turn, impose upward pressure on interest rates, Goldman Sachs analyst Praveen Korapaty noted. The U.S. federal budget deficit is already at the highest level in six years for the 2018 fiscal year, jumping 17% to $779 billion, based on the Treasury Department’s latest report.

Red Wall tail risk removed

“[T]he injection of further stimulus at this stage of the cycle would potentially have necessitated more policy tightening by the Fed, or if the Fed did not act, higher inflation—both additional factors pointing to higher rates,” Goldman Sachs analyst Praveen Korapaty wrote in a note.

“The immediate bull flattening seen in the Treasury curve once the outcome of the election became clear, alongside a modest weakening in the Dollar, especially against higher-beta FX such as ZAR, IDR and MXN in EM and AUD and NZD in G10 are, in our view, a reflection of the removal of this expansionary tail risk.”

To be sure, while a “Blue Tsunami” midterm result lagged behind as an unlikely outcome, it too would have carried downside risks to markets.

“Without fiscal stimulus/deregulation as a catalyst, the possibility of calls for impeachment and increased investigations would likely intensify the overhang on sentiment,” Barclays analyst Aroop Chatterjee wrote in a note ahead of midterm results.

Markets reflected this notion after midterm results began trickling in Tuesday night, with equity futures trading higher after several key Democratic losses. “This shows that the markets feared a blue wave,” Ryan Nauman, a market strategist for Information Investment Solution, told Yahoo Finance.

For now, markets can rejoice the Goldilocks midterms outcome.

“In a dispassionate way the equity markets probably got the outcome they wanted,” Jefferies analyst Sean Darby said.

—

Emily McCormick is a reporter for Yahoo Finance. Follow her on Twitter: @emily_mcck

Follow Yahoo Finance on Twitter, Facebook, Instagram, Flipboard, LinkedIn, and reddit.

Read more from Emily:

Netflix user growth beats expectations, shares spike

Now is a ‘once-in-a-lifetime chance’ to invest in US pot companies, investor says

There are ‘4 headwinds’ facing markets rights now

Ark Invest CEO: Tesla ‘is a replay of Apple’

China’s slowing economy could be a problem for Apple