By Michael O’Neill

The White House shrew was not just tamed, it was nearly drowned beneath a blue wave, the likes of which have not been seen in nearly 50 years. If the first half of Trump’s second term was an examination, the electorate just handed him an F.

The Democrats’ return to control the House and the Senate is a historic political rebuke of Trump’s administration, leaving him facing a legislature that will be considerably less accommodating during the remaining two years of his presidency.

The result could have implications for everything from trade policy and government spending to Federal Reserve independence, Treasury yields, the US dollar and traders have taken notice.

Independence Day

“Today we celebrate our Independence Day.” Those are the immortal words of fictional President Whitmore, delivered after Captain Hiller, played by Will Smith, helped save humanity in the 1996 movie Independence Day. Today, those same words may be echoing through the halls of the Federal Reserve Building.

Trump has spent considerable time ranting about the failings of the Federal Reserve for ignoring his demands to lower interest rates. He ordered a Justice Department investigation into former Chair Jerome Powell’s handling of the Fed’s building renovations, unleashed innumerable personal attacks and attempted to remove Governor Lisa Cook over allegations of mortgage fraud. Those attacks sparked what passes for rebellion among FOMC policymakers.

Powell defied convention by refusing to relinquish his seat on the Federal Reserve Board of Governors after being replaced as Chair by Kevin Warsh. His term as a governor runs until January 2028, and he has indicated he intends to remain until the investigation into the renovation project is resolved. Vice Chair Philip Jefferson could follow a similar path when his term as vice chair expires in September 2027. His separate term as a governor runs until 2036.

Trump can still nominate Fed governors, but with Democrats controlling the Senate, he faces a formidable obstacle. The Senate must confirm presidential nominees, giving Democrats an effective veto over future appointments. The bond market is delivering its own verdict.

Treasuries Take Notice

Bond traders have decided that that the Democrat sweep will restrain federal spending which to some seems counter-intuitive. Fiscal restraint and Democrats are rarely found in the same sentence.

Nevertheless, US 10-year Treasury yields have plunged from 5.19% just three weeks ago to 4.88% today, while the 2-year Treasury yield dropped to 4.57% from 4.91%. That may ease some concerns about additional government borrowing, although Washington’s $40 trillion-plus debt burden isn’t going away. Those falling yields led to sharply narrowing Canadian and US interest rate differentials which gave the loonie wings.

Blue or Red-Canada Still Gets Trumped

Trump may have got his comeuppance, but Canadians shouldn’t start celebrating. Losing Congress hasn’t cost him his ability to disrupt trade, impose tariffs and create economic uncertainty. His veto pen and book of executive orders says so.

The Canada-US two-year yield differential has narrowed to approximately 134 bps, from around 155 bps in October, while the ten-year spread has tightened to 118 bps from roughly 132 bps. The spread could narrow further due to the Bank of Canada’s warning that additional increases may follow the recent 25 bp hike to contain inflation. That reduction drove USDCAD from a mid-October peak of 1.4295 to 1.3930 on November 4.

The Bank of Canada’s post rate hike tightening bias contrasts with the Federal Reserve’s decision to leave rates unchanged. The prospect of a more hawkish Bank of Canada and a narrowing yield gap is providing the loonie with some welcome support, although falling crude prices are acting as a drag on gains

War Premium Rebate

Oil traders are rapidly unwinding the geopolitical risk premium that had pushed WTI oil prices to $104.86/b on October 30, knocking them back to $88.45/b in New York today. Trump’s apparent willingness to give diplomacy with Iran more runway, coupled with indications that Tehran is receptive to Qatar-mediated negotiations, has taken some of the urgency out of the supply-disruption threat.

However, expectations for sharply lower prices may be premature because although diplomacy is hard at work, supply chains have been damaged and disrupted.

The shrew may be tamed somewhat, but it is still feral.