Market-Moving Political Surprises to Come After Mid-terms

I am not excited by the mid-terms (full disclosures: I voted). We’ve known for months that the GOP would gain the House, and likely the Senate. Pollsters expect the GOP to have about 245 seats out of 435 in the House and a slim majority in the Senate.

The market consequences are not that important and, by now, must be fully priced in.

We will get policy paralysis because the GOP won’t have a large enough (filibuster proof or 60 votes) Senate majority to pass legislation without Democratic support. And the scope of bipartisanship is likely to be limited to topics such as economic nationalism, containing China, and military spending. 

In addition, the WH will be able to veto Bills, and Congress won’t have the majority needed to override a presidential veto (290 votes in the House, 66 in the Senate).

The market-moving political surprises are likely to come after the mid-terms. I can see 2 important ones.

First, will the democrats lift the debt ceiling during the lame duck (i.e., the period after the mid-terms and until end-year)? The debt ceiling is likely to be hit in March and GOP lawmakers are planning to use it as leverage to extract some fiscal consolidation, for instance by imposing a budget deficit around 2.5% of GDP, against 5.5% in FY2022 (the latter includes the full cost of  student debt forgiveness or about 1.5% GDP). 

However, the Democratic leadership has been floating the idea of raising the debt ceiling while they still control Congress (during the lame duck) through reconciliation. This would make for more expansionary fiscal policy because, even though the GOP would still have to approve government spending, it would have much less leverage. 

The most likely fiscal policy scenario would then be for a series of continuing resolution (short term funding measures extending current fiscal policy) to get adopted through the next election cycle. This is because neither party will want to be seen as responsible for shutting down the government. Under this scenario, the FY 2023 budget deficit could be about 4% of GDP.

Because raising the debt ceiling during the lame duck would be controversial it would likely be announced after the mid-terms.

Second, will former president Trump run for office? On 7 November, Mr. Trump announced ‘I’m going to be making a very big announcement on Tuesday, 15 November.’ It is likely that, based on the performance of his candidates in the mid-terms, Mr. Trump will announce that he is running in 2024. If so, his candidacy is likely to set the political agenda up to the 2024 elections. 

President Biden has also announced he intended to run, though there is still no consensus on his candidacy among democrats.

Polls currently show both candidates neck in neck, but this is likely to change. As we saw in 2020, Mr. Trump’s victory had a strong positive market impact and polls showing him moving away from his adversary could have a market impact.

So, let’s wait until after the mid-terms, when the more important political news are likely to come out.

Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed , the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)