US midterm elections: Is gridlock good?

Further tax cuts unlikely but will Trump strike a deal on trade?

Keith Wade, Chief Economist, says:

“The midterm elections restored some faith in opinion polls with the Democrats taking the House of Representatives and the Republicans holding the Senate. Conventional wisdom has it that a gridlocked Congress is good for markets as it prevents politicians from interfering in the economy. However, US markets have received a considerable boost from the president’s tax cuts and deregulation measures.

“Going forward, gridlock means less fiscal support for the economy as Democrats are unlikely to back further tax cuts. This could create a problem for US growth in 2020 when the existing package fades and is not replaced by further measures. It is possible that the president and the Democrats could strike a deal on infrastructure spending, but they may hesitate to take measures that could help get Trump re-elected as president.

“Faced with a potential block on fiscal policy, the president may turn to trade policy and look to strike a deal with China and so prevent a further damaging escalation in the trade war. From an economic perspective, that would be the logical step. However, Trump will have to weigh up whether the economic costs outweigh the political benefits of playing to his base support – many of whom see tariffs as an essential part of putting America first.”

Future policy will require bipartisan support

Frank Thormann, Portfolio Manager, Multi Regional Equity, says:

“Two important implications from this election will be stronger presidential oversight and increased political gridlock. Democrats now have a much larger ability to put a check on the president’s power and have promised to intensify investigations into allegations such as the Russian 2016 election interference.

“Because both houses are required to pass legislation, future policy will require much greater bipartisan support, which is a dramatic change from the past two years and is likely to materially alter the remainder of the Trump presidency. One immediate impact of this is a lower likelihood of further fiscal stimulus, which is slightly weighing on the US dollar this morning.”

Larger Republican Senate majority is significant

Frederick Schaefer, Head of Equities Management, US Small Cap Product Managers, says:

“In a rebuke rather than a rejection of the president, US voters have elected a divided Congress. The Democrats gained control of the House of Representatives after eight years as the minority party.

“In the House, a number of Republican moderates lost or chose not to stand for re-election. This means the Republican House caucus will become more conservative and more Trump-like. The new House Democratic majority will be more challenging to the president on a number of issues. Consider the possibility of a House committee issuing a subpoena for him to release his tax returns.

“On the Republican side, the larger Senate majority is a significant accomplishment. Additionally, Republican gubernatorial candidates fared well, winning races in key states such as Ohio and Florida. As we approach the 2020 elections, these two states are significant prizes in presidential elections.

“In an interview on the eve of the election, Mr Trump conceded that maybe he should have toned down his rhetoric during his first two years. Perhaps this may presage a less bellicose president and less contentious Washington. But don’t count on it.”