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As of this writing, narrowly divided government is still the most likely outcome of the recently held US midterm elections, in line with polls heading into election day last week. Matching our (and the market’s) baseline expectations, Republicans look set to win control of the House of Representatives, while the fate of the Senate still hangs in the balance (likely to remain Democratic-controlled), with results in a few key states yet to be confirmed.
The Republican House majority will likely be lower than consensus expectations and with a smaller margin than they (Republicans) would have hoped for. Democrats managed to wrest a key Pennsylvania Senate seat from Republican control. A strong performance by Republicans in Florida has added to the momentum Governor Ron DeSantis has built up to challenge former president Donald Trump in the Republican 2024 presidential primary. Democrats have so far fared better than expected, especially given the US inflation headwinds faced by the Biden administration (as reflected in the President’s low popularity rating). Should the above dynamics hold after final results, House Republicans would likely have an extremely difficult time governing with such a narrow majority.
A Republican majority in the House also sets up another potentially contentious US debt-ceiling showdown, as well as Republican attempts to repeal or water down key provisions of the Inflation Reduction Act passed earlier this year.
Impact on markets and economic policy: While markets are still digesting incoming election tallies, it is safe to say the results did not come as a big surprise to anyone, nor have they yet had much direct impact on US market movements. The day after election day was a bearish one for most US market sectors. Treasury yields ended marginally lower, while equity indices declined (led by the tech sector) following renewed turmoil in the cryptocurrency markets. Oil slumped by 3.5% after a US government report showed gains in national inventories.
Under the baseline scenario laid out above, we think a divided US Congress will mean lower odds of any ”big-bang” policy reforms that would have furthered the Democratic agenda, such as progressive measures in support of childcare, housing, home health care, college affordability, and social redistribution via higher taxes (including potential “windfall” levies on the energy, pharma, and insurance sectors.)
Geopolitical and industrial policy: A hawkish stance on China is perhaps one of the few US policy objectives for which there has been bipartisan support in Washington. The recent subsidies announced by the US government for chipmakers largely reflect political recognition of semiconductors’ importance to national security (i.e., advanced weapon systems), not just technology’s prevalence in everyday life. The US has announced increasingly expansive controls on exports of advanced chips and chip-production equipment to China, citing concerns about dual military-civilian use of such technology. We expect no major shift in this generally hawkish US policy approach to China.
Broadly speaking, we think the same principle (status quo) will apply to US policy toward the Russia-Ukraine conflict, although a Republican-controlled House could try for energy policy changes by marginally favoring the conventional energy sector, given the considerable influence exerted by fossil-fuel producers in traditionally ”red” states.
Political pressure on the Fed: Select leaders within the Democratic party have “warned” the US Federal Reserve (Fed) against enacting excessive interest-rate hikes designed to lift the unemployment rate and bring down persistently high inflation. There is a contingent within the party that clearly views higher unemployment as a more significant problem for the economy than elevated inflation and wants the Fed to wait for the “lagged effects” of the policy actions it has already taken to kick in. We think shared power in Congress will likely curb some of the potential excesses in terms of political pressure on the Fed.