U.S. Electorate Splits Power in Mid-terms

The U.S. Mid-term elections saw the U.S. Democratic Party regain control of the House of Representatives but fail to win the Senate in a shift some analysts fear could create legislative gridlock and sow further political division.

Key takeaways

  • Business investment may slow with investors more cautious on risk
  • Some short-term market volatility anticipated
  • Pace of U.S. interest rate increases may slow

The November 6 vote saw the Democratic Party take hold of the House of Representatives but with the Republican Party winning additional seats in the Senate, the result was a split Congress.

Assessing the likely future impacts of the result, Standish1 Chief Economist and Investment Strategist, Vincent Reinhart, has concerns about the future balance of power in Congress. “In 50 years over the past century, the levers of power of the President, House, and Senate were split between the two parties. This, however, will be an extremely divided government over the next two years,” he says.

“The Democratic leadership in the House will likely direct various committees to launch investigations of the President’s performance, re-litigate appointments and pressure agency heads to walk back their deregulation efforts.

“This election result also creates a headwind for economic activity in two ways. First, uncertainty about economic policies is a decided impediment to private sector decision making, and business people and investors will be unsure of the direction of future legislation, regulation and enforcement, importantly, including whether the 2017 tax cuts will be rolled back in 2021.”

BNY Mellon Investment Management Chief Economist, Shamik Dhar, agrees the latest political change could negatively impact Trump’s tax plans and he sees limited room for cooperation between Republicans and Democrats post the U.S. Mid-terms.

“Stalemate between the administration and Congress means big tax cuts are most likely off the table, so perhaps we may see a small shift downwards in future rate expectations and bond yields; the dollar might come off a touch too, with U.S. equities broadly unchanged in the short-term,” he says.

“Both sides have an interest in passing more infrastructure spending but the Democrats will not want to give the President a boost in the final two years of his first term, so impasse remains the most likely outcome on spending. I think healthcare should rally with this result, since the repeal of Obamacare is no longer likely, though pharmaceutical companies and health insurers could suffer.”

While many predict heightened political tension in Congress, Mellon Capital’s1 Investment Strategist, Jason Lejonvarn, still sees some scope for compromise. “On the legislative agenda expect some Democratic compromises on border security in exchange for some focus on U.S. infrastructure spending and noise around tax relief for the middle class. The Democrats will likely encourage President Trump’s sabre rattling on trade with more focus on China and less on historic allies. As both parties gear up for the 2020 U.S. elections, neither party will be willing to hand the other a major legislative achievement. Given this result, we do not expect an imminent impeachment battle.”

Volatility concerns

At a market level, some wider concerns about spiking volatility remain. From a bond market perspective, Newton’s Head of Fixed Income Paul Brain has concerns over potential political gridlock. “It could result in a freeze in decision making, which might undermine the Dollar and slow the pace of rate increases,” he adds.

Brendan Mulhern, Global Strategist on Newton’s Real Return team, adds: “Markets may have to countenance the prospect of an unwinding of the market-friendly policies implemented by the Trump administration or, at the very least, an end to further easing as political gridlock returns to Washington. Under this scenario, it is likely market sentiment will be impacted negatively.”

However, despite the mixed Mid-term results and an increasingly febrile atmosphere in U.S. politics, some investment managers do see positives in the outcome. Paul Markham, Global Equity manager at Newton, believes victory for the Democrats in the House is unlikely to impact market sentiment unduly. Meanwhile, Jim Lydotes, Portfolio Manager with The Boston Company1, believes a more divided Congress could actually benefit U.S. infrastructure development.

Lydotes says: “Going into the 2016 elections, infrastructure was the one topic that both Republicans and Democrats agreed on. While we have not seen an extensive infrastructure spending plan, we have seen President Trump’s administration remove many regulatory hurdles. The previous administration implemented a number of environmental policies that slowed down energy and utility infrastructure building. Over the past two years, we have seen a loosening of some of these policies. This can be seen as positive for business and energy infrastructure development.” Lydotes also believes the Republican’s retention of a Senate majority is supportive of the development of a larger infrastructure program.

What next for the Fed?

Reinhart remains doubtful on the outlook for U.S. business investment. He sees little chance of new bills getting signed into law thanks to the partisan nature of U.S. politics in a newly divided Congress.

“If the President is even more assertive on trade and immigration, there is some risk that tariffs and restrictions could pose an adverse cost shock to the U.S. economy. These forces combine to slow economic growth, likely leading the U.S. Federal Reserve (Fed) to trim back its rate hiking intentions and prompting investors to be more wary about risk,” he concludes.

Lejonvarn also believes the new balance within Congress could blur lines and generate fresh economic uncertainty.

“This may create ambiguity as to whether the recent tax cuts are permanent and whether de-regulation will continue to win the day. In an uncertain environment, business investment may slow and investors may be more cautious about risk. The Fed will likely continue tightening but if the economy slows either as a result of the risk-off sentiment and/or the effects of continuing trade wars then the Fed may not have to be as aggressive as forecast,” he concludes.

1Standish, Mellon Capital and The Boston Company are brands of BNY Mellon Asset Management North America Corporation.

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