About the authors: Larry Hatheway and Alex Friedman are the co-founders of Jackson Hole Economics and the former chief economist and chief investment officer, respectively, of UBS.
To the surprise of many observers (including ourselves), the midterm elections turned out to be more contested than most polls and political futures had indicated. The political tipster community has had perhaps the longest night of all and will be licking its wounds in the days ahead.
The long-awaited “red wave” did not materialize. While Republicans look set to emerge with a slim majority of perhaps 5-10 seats in the House of Representatives, the Senate remains a toss-up and the two major parties have battled to a stalemate in gubernatorial and local elections. At most, a Republican ripple crossed the American political pond on November 8.
So what does this mean for investors, and more importantly, for America?
For starters, markets don’t like uncertainty. This alone may explain why stock markets plunged the next morning. And uncertainty over the outcome in the U.S. Senate could drag into next month, given that control of the body may not be known until a possible runoff election for Georgia’s disputed Senate seat on December 6.
Uncertainty may also linger if close races for the House of Representatives and Senate are then contested in court. After the events leading up to and including January 6, 2021, one can only hope that the fighting takes place within the confines of the law.
Second, and in view of the 2024 elections, both parties will begin to draw political conclusions that will shape their political platforms at home and abroad. For Republicans, the party will grapple with candidate selection, how much of a liability former President Donald Trump’s declining popularity is now, and whether social issues — especially the Dobbs decision that overturned Roe v. Wade – robbed them of the typical medium-term gains they had anticipated. Democrats, on the other hand, will have to be careful not to forget that polls indicate they are less reliable on economic issues, with inflation and stagnating living standards topping voters’ grievances. And the question of whether President Biden will decide to run for a second term looms on the minds of many. In all these ways, the first mid-term results did not bring clarity. Uncertainty reigns.
Third, as markets were boosted heading into the medium term by the prospect of a lockdown, which was seen both as exerting deflationary pressure by freezing US tax and regulatory laws and providing US businesses with greater clarity in which to plan and invest over the next couple of years, that the costs of the traffic jam can now weigh on occupants of corner offices and meeting rooms.
After all, while a narrow Republican majority in the House would ensure they wield the president’s mighty gavel and control key committees, it could also make the GOP even more beholden to the more radical elements of its party. In other words, whoever becomes Speaker of the House of Representatives will need the support of Georgian Marjorie Taylor Greene and other far-right MAGA members to maintain control in the lower house.
To mix metaphors, the Republican ripple could run aground with “big tails,” the biggest of which could be the political brawls that could ensue both within the GOP and between Congress and the Biden administration. about raising the US debt ceiling. Remember that Congress must pass a law, which the president must then sign, to increase the country’s borrowing power. The need to raise the debt ceiling is expected to be before the new Congress in the first quarter of 2023.
The concern is that radical Republicans in Congress could threaten to shut down the government if they see fit politically. The United States is over $30 trillion in debt and is approaching its legal borrowing limit. If the cap is not raised by early 2023, the faith and credit of the US government could be at risk. Republicans have used the debt ceiling as a political pawn twice before, including under the Clinton and Obama administrations, and each time markets slumped. The 2011 debacle cost the United States its AAA rating. The premise Republicans have learned from past election backlash against the debt crisis rests on shaky foundations, given how much the GOP has changed over the past decade and how little the MAGA crowd seems to care about. party traditions.
Fourth, while the stalemate virtually guarantees that major fiscal policy shifts are not on the cards for the next two years, this may not be a source of lasting good news for markets. Certainly, tying Washington’s hands on taxes and spending eliminates the possibility that further fiscal stimulus will further fuel inflation. But it also means that full responsibility for US macroeconomic stabilization policy will rest exclusively with the Federal Reserve. Yet if the myriad economic challenges we face today — from Fed tightening to war in Ukraine to a weakening Chinese economy — conspire to push the U.S. economy into deeper recession or longer, markets may regret the loss of effective countercyclical fiscal policy. The legislative deadlock means the US will have to rely exclusively on monetary policy stimulus to stage a recovery once inflation is brought under control. It’s worrying. If we have learned one thing over the past few decades, it is that monetary policy has lost its potency.
Fifth, a legislatively crippled President Biden has only two avenues to advance his agenda: executive orders and foreign policy. As a committed lawmaker with nearly four decades of experience in the US Senate, Biden is less likely than former Presidents Trump and Obama to circumvent Congress with pervasive executive orders. He must also be wary that a partisan and politically hostile conservative majority in the Supreme Court could thwart him. And in foreign policy, aside from climate change, there are fewer differences between Biden and Trump than many realize. Biden is likely to sharpen his rhetoric toward China. He has shown no inclination to scrap tariffs and is likely to propose higher defense spending, which will anger both China and Russia. At the same time, US policy toward Ukraine could become a flashpoint, given MAGA’s close ties to Russia and the movement’s stated aversion to funding military support for Ukraine.
Finally, a divided government makes it impossible to advance legislation on major climate initiatives or health care reform, including Medicare negotiations to lower prescription drug prices. Over the next two years, Dirty Energy and Big Pharma will get a break (from the inevitable), but investors who pile into it should know they’re on the wrong side of the equation. history (of the investment). A divided government will not undermine the misnamed Inflation Reduction Act, and federal infrastructure spending and clean energy grants will not be reversed.
Ultimately, even though Wall Street might have welcomed the standoff, investor joy is already waning. The mid-term reviews clarified little compared to what they muddled. To the extent that political paralysis is the key takeaway, it hampers the government’s flexibility to stabilize the economy or markets, should that become necessary. Traffic jams also hamper much-needed investments in education, training and health, or the ways in which society can cope with climate change and its impacts on the economy. In a world of growing geopolitical tensions, the standoff does nothing to reassure investors that even worse outcomes abroad will not materialize.
Markets are notorious for being myopic. Last night’s non-result should make investors look up. It remains to be seen if they will.
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