UBS warns: The US midterm elections will bring significant market volatility; this is currently the "calm before the storm."

"This could be the calm before the storm," UBS chief economist Arend Kapteyn wrote in a research note on Wednesday. He pointed out that with the U.S. midterm elections approaching, stock market volatility has historically increased significantly during this period, and this year is unlikely to be an exception.

Kapteyn cited data showing that since 1928, September and October have been the most volatile months of the year—volatility climbs during this period regardless of whether it is an election year, before falling sharply.

The stakes for control of the Senate are now close to 50/50, and Kapteyn believes that "there is little reason to believe that this year's uncertainty and volatility will be lower than in previous midterm election years."

Historical pattern: Prices fall before elections and rise after elections.

Data shows that in midterm election years, the S&P 500 typically declines from the end of August to the beginning of October, but by March of the following year, the average return is about 14%, and the median return is as high as 16.4%.

In contrast, the average return during the same period in non-midterm election years was less than 5%.

There are exceptions to this pattern: the 1978 inflation shock, the bursting of the tech bubble in 2002, and the trade war coupled with the Fed's tightening in 2018 all broke the convention of "post-election rebound".

The ruling party losing seats is commonplace, and the balance of power in both houses remains unresolved.

Kapteyn cited historical data, pointing out that since 1950, the ruling party has lost an average of 25 House seats and 3 Senate seats in midterm elections.

Andrew Tyler of JPMorgan Chase also shared his baseline scenario with clients: across 23 midterm election cycles since 1934, the ruling party has lost an average of about 27 House seats and about 3 Senate seats.

Applying historical patterns to the current situation—with Republicans holding a 218-seat majority in the House and a 53-47 lead in the Senate—historical predictions pointed to Democrats regaining control of the House and Republicans retaining control of the Senate.

Betting data confirms this assessment: Kalshi data shows an 85% probability of Democrats regaining the House of Representatives, but only a 53% probability of Republicans retaining the Senate, indicating a very close contest. Polymarket data shows that the market has already priced in a significant Democratic sweep of both houses of Congress.

Wall Street institutions have issued warnings

Bank of America strategist Michael Hartnett predicts that the market will experience a sharp decline if the Democrats sweep both houses of Congress.

Traders' concerns are focused on the policy front: Democrats have signaled a possible push for tighter regulations and a data center shutdown order, which is seen as a direct threat to AI-related assets.

Kapteyn concluded his research report by asking again: "The calm before the storm?"

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