Gridlock, Blue Sweep or Red Repeat?
Wall Street is closely watching the U.S. midterm Congressional elections next
week, as policy decisions that could sway the economy, corporate
decision-making and consumer spending hinge on the results.
Should his
fellow Republicans maintain or extend their grip on Congress, President Donald
Trump may be emboldened to pursue more of his political agenda, including
further tax reforms.
By
contrast, Democratic gains that allow the party to control the House of
Representatives, and possibly the Senate, could stifle Trump’s policy aims and
perhaps lead to attempts to impeach him.
Investors
are bracing for a split Congress, in which Democrats win the House but
Republicans hold the Senate, a reflection of current polling data and online
betting markets.
Sentiment
could change though in the last week before the Nov. 6 elections and investors
are quick to recall that Trump was losing in polls ahead of his surprise
victory in the presidential election of 2016.
Midterm
congressional elections “typically are not a major U.S. market event, let alone
a global market event, but this time may be different,” Citigroup analysts
wrote in a recent note.
Here is a look at how the election
results could affect different asset classes:
STOCKS
A Democratic takeover of the House might spook the stock
market because of concerns about political instability, including hearings
involving the Trump administration.
But the fall in U.S. stock prices this month may be
increasingly pricing in such a split Congress, so that scenario may not
significantly shake the market.
Even if Democrats win the House, legislative gridlock may
reduce the chances of major policy changes if Republicans retain control of the
Senate.
However, an infrastructure spending package is one area
where Trump and Democrats could find compromise that boosts equities.
A Democratic sweep of the House and Senate would likely
surprise the market and prompt a sell-off in stocks.
The potential for Democrats to alter Trump’s tax-cut
package or to start impeachment proceedings could jar investor and business
confidence.
A Republican win that allows them to retain total control
of Congress could lift stocks as it would increase the chances of more tax
reform and further de-regulation.
The market would keep one eye on the Federal Reserve
though if Congress were to stimulate economic growth further with more tax cuts
or spending which may push inflation higher and lead to higher interest rates.
A Republican victory could also embolden Trump to pursue
his protectionist international trade policies with even more import tariffs.
“The initial reaction might be positive, but there are
some negative potential consequences to it if there is no real check on
administration policies,” said Rick Meckler, partner at Cherry Lane Investments
in New Vernon, New Jersey. “Those policies, both in trade and in taxes, have
been pretty inflationary.”
U.S. DOLLAR
If the
Republicans retain both the House and Senate the U.S. dollar may benefit,
analysts said. Given the disruption to international product supply lines and
rising input costs resulting from Trump’s tariffs, the dollar is perceived as a
safe haven and it strengthened after levies were imposed on Chinese, European,
and Canadian imports this year.
A divided
Congress, however, is perceived as negative for the dollar, analysts said,
because it is unlikely that any new fiscal stimulus could be launched to
counterbalance forecasts of slowing U.S. economic growth next year.
A
Democratic sweep of Congress could also undermine the dollar, if it leads to
complete gridlock in Washington D.C. as it raises the risk of government
shutdowns and suggests a more volatile political environment ahead of the 2020
U.S. presidential election.
A
Democratic Congress could roll back some of the Trump administration’s trade
policy measures and help other currencies such as those in emerging markets,
analysts said.
EMERGING MARKETS
The outlook
for emerging markets is linked to U.S. dollar strength and trade policy
tensions. Emerging market assets will likely respond inversely to movements in
the U.S. dollar after the elections.
A
Democratic takeover of one or both chambers of Congress would reduce the
tension in trade talks with China according to Bertrand Delgado, director of
emerging markets at Societe Generale in New York.
A
Republican sweep could translate into a selloff in emerging market assets as
international trade spats would be expected to continue. China has weighed the
most on emerging market equities following a slowdown in economic growth due to
the trade war with the United States.
BONDS
Should
Democrats take one or both chambers of Congress, further efforts to change the
tax code would likely stall, but Democrats may be unable to roll back the
Republican tax cuts enacted last December or to increase spending on social
programs.
As a result
the federal deficit will be unlikely to grow at a faster rate or require
additional borrowing than is currently forecast and this could be mildly
positive for bond prices.
“We are looking for a split government which means nothing will get done,” said
Gennadiy Goldberg, interest rate strategist at TD Securities in New York.
One caveat:
If a split government leads to a government shutdown as a negotiation tool, it
could spur safe-haven bids for U.S. Treasuries.
If
Republicans retain their edge in Congress, the fiscal outlook is complicated by
how they will tackle the budget deficit.
They might
attempt more tax changes which can increase the deficit. Any changes may be
offset by efforts to cut entitlement programs or to end the Affordable Care Act
though the net impact on federal borrowing is unclear.
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