Republicans Win Congressional Elections. What Does This Mean for the Economy
In the United States, the House of Representatives and a third of the Senate are re-elected. Republicans are likely to win a majority in the lower house and can expect to win in the Senate. We figure out how a change in the balance of political forces will affect the economy and the US stock market.
This year’s midterm elections are marked by particular economic and political vulnerability in the United States. Inflation that persists despite all the efforts of regulators, a more than 50% chance of a recession, the pressure of rising interest rates and the expectation of further geopolitical escalation make not only the American but also the world community closely monitor the voting results.
The elections will determine the composition of Congress, which has the authority to develop fiscal policy, trade with foreign countries and regulate the public debt.
Here’s how the economic picture in the United States could change in the event of a Republican victory, and how it will turn out, in particular, for the stock market.
What will the elections affect?
Tax changes
Last week, President Joe Biden proposed an excess profit tax on major oil and gas companies that recorded record quarterly profits due to high energy prices. According to Biden, companies should direct additional income to the expansion of production and investment, and not to pay dividends.
Representatives of the oil industry disagreed with the president’s position: according to them, raising income taxes would be the least likely to increase investment in production capacity.
Republicans, if they win a majority in Congress, are less likely to approve a windfall tax: Representatives of this party, as a rule, do not support raising taxes on the rich.
“What does the midterm elections mean for the markets? If the Republicans get the House of Representatives, there will be no tax increase,” said David Wagner, portfolio manager at Aptus Capital Advisors.
As far as tax cuts are concerned, if the Republicans gain control of Congress, it will be difficult to pass such legislation without some support from the Democrats or President Biden himself.
National debt ceiling
The last time lawmakers raised the national debt ceiling was in December 2021, and they will likely have to raise it again next year. This guarantees the US the ability to borrow the money it needs to run the government and the $24 trillion Treasury bond market.
Republicans may demand drastic spending cuts in exchange for a higher debt ceiling. If the government is divided, this could negatively affect the markets.
When this situation arose under the Obama administration in 2011, the US lost its AAA credit rating from Standard & Poor’s and the US stock market fell more than 5%.
The debt ceiling sets a limit on how much the Treasury can lend to the government to pay for expenses. Once the ceiling is reached, lawmakers must raise the limit or face default on the US government, giving the Republicans a bargaining chip to advance their fiscal agenda.
“You can’t just keep spending and increasing debt… There comes a time when you have to say, ‘OK, we’ll give you more money, but you have to change your current behavior,’” said Kevin McCarthy, who is expected to be the next speaker. House of Representatives if the Republicans win a majority.
Expenses
Democrats have said they intend to focus on those parts of Biden’s 2021 budget program that have yet to be legislated. It is about expanding coverage of medical care and tax benefits for child care. Republican resistance in Congress could disrupt those plans.
In addition, economists at Goldman Sachs note that Democrats may push for an expanded application of federal fiscal measures in the event of a recession, while Republicans are likely to prefer to avoid costly bailout packages.
The results of the vote may also affect the financial assistance that the United States provides to Ukraine. Earlier, Republicans and Democrats approved a multibillion-dollar funding package - a rare example of the unity of the two parties, but McCarthy hinted that if the Republican Party wins, it may revise the amount of allocated funds.
Social Security
Popular programs such as Social Security and Medicare face the problem of financial solvency and have already become the subject of debate between representatives of both parties.
Social Security is an American old-age, survivor, and disability insurance program. Medicare is the US national health insurance program for people aged 65 and over.
Democratic Senator Joe Manchin said last week that Social Security spending programs need to be revisited. At the Fortune CEO conference, he said he advocates legislation over the next two years to limit the provision of benefits whose programs face “huge problems.”
Republican Senator Rick Scott has proposed a vote to update nearly all federal spending programs every five years.
Analysts say this could lead to cuts in funding for Social Security and Medicare.
Federal Reserve System
The US Federal Reserve continues to raise rates at an accelerated pace: since March, the federal funds rate has risen from near zero to 4.75-5%. Such drastic measures to combat inflation are worrying lawmakers and economists, who believe that the Fed’s aggressive policy could plunge the US into recession.
Democratic senators - Elizabeth Warren, Banking Council Chairman Sherrod Brown, John Hickenlooper and others - called on Fed Chairman Jerome Powell to slow down the pace of rate hikes.
Senator Pat Toomey, the top Republican on the banking committee, asked Powell last week to refrain from buying back government bonds if market conditions remain stable.
How will the stock market react?
Although Biden took office when the stock market was on the rise, as the midterm elections approached, the markets were dominated by pessimism.
As of Tuesday, the S&P 500 is down 0.6% since Biden took office in January 2021. According to a CFRA study, this is the second-worst figure in the first 656 calendar days of a president’s tenure since former head of state Jimmy Carter.
Of 13 presidents since 1953, Biden ranks ninth in stock market performance in two years in office, only ahead of former presidents George W. Bush (-32.8%), Jimmy Carter (-8.9%), Richard Nixon (-17.2%) and John F. Kennedy (-2.1%), according to CFRA.
By contrast, during the midterms under Biden’s two immediate predecessors, stock markets rallied exponentially. The S&P 500 rose 52.2% in the first 656 calendar days of former President Barack Obama’s tenure and 23.9% under former President Donald Trump, according to the CFRA.
Regardless, investors may remain bullish on the stock, according to Morgan Stanley strategist Mike Wilson. In his opinion, the victory of the Republicans in at least one house of Congress will support low bond rates and ensure the continuation of the rally in the bear market of stocks.
Wilson and his team believe that short-term volatility is to be expected ahead of the midterm elections, especially given concerns about Thursday’s consumer price data. However, they are tactically bullish on equities, believing that rate volatility will further level out.
The firm predicts that the S&P 500 could rise to 4,000 to 4,015 this week if Republicans gain a majority in the House and Senate, making it harder for Democrats to legislate large spending expansion plans. However, analysts say that for the stock market rally to continue into the holiday season, 10-year Treasury yields will need to decline.
“If the 10-year Treasury yield hits a new high (4.35%), the likelihood of stocks rallying to higher levels (>3950) is significantly reduced, and we would advise clients to consider exiting bull trades at this point.”, the note says. At the beginning of the week, the yield on ten-year bonds was 4.2%.