While there are open questions, don’t expect much from Congress. The attention now turns to tomorrow’s FOMC meeting.
Stocks continued their recovery from the October swoon yesterday as investors focused on the mid-term elections. The outcome, a split decision with the Republicans gaining seats in the Senate and Democrats wresting control in the House, seemed to satisfy the majority as futures point to another positive opening today.
While the headline results were just about in line with consensus there were some nuanced outcomes that bear mentioning. It appears the power of President Trump, the campaigner, were reinforced by this election. His focus was on retaining the Senate and he campaigned hard for a lot of Republicans headed for tight races. Much of his attention was concentrated on races involving Democrat incumbents in Red states running for reelection. While there are still three undecided Senate races (all of which are leaning Republican at the moment), it appears likely that the Republicans can gain as many as three seats. If that stands up, the Senator with the most to lose could be moderate Susan Collins of Maine. She was often the swing vote in tight contests. With a larger Republican majority loyal to Trump, her power to be the pivotal decision maker could be reduced. What all this means is that the ability to get more conservative judges appointed will increase. Should another Supreme Court seat open up in the next two years, it would appear to be certain that another very conservative person would be seated without nearly as much to do as we just witnessed with the Kavanaugh confirmation hearings.
While Republicans can bask over the Senate victories, the House pivoted the other way. At the moment, with about a dozen races still outstanding, it would appear that the Democrats will control at least 225 seats and take over control. Unlike in the Clinton years, when there were many Blue Dog conservative Democrats in the House, the make up this time is almost 100% liberal. Thus, at least between now and 2020, the odds of more tax cuts or the ability to make last year’s tax package permanent have been sharply reduced. Total repeal of Obamacare is also highly unlikely.
There remain a lot of open ended questions that could be resolved fairly quickly in 2019.
- Will there be any hint of cooperation between a Democratic-led House and President Trump? – Perhaps a lot will settled early when the House picks a Speaker. Nancy Pelosi, of course, wants to return to that role and she has promised to try and work with the President to find common ground. While she is effective as a leader and has a strong base of popular support, there is also vocal opposition. If House leadership decides to spend a lot of energy investigating Trump or doing other things deemed obstructionist, such efforts could backfire if not grounded in a very strong factual base. The elections yesterday clearly demonstrate just how divided America is and the divisions are about equal in size. There is a small centrist base that actually likes many of Trump’s policies but don’t like him personally. That is the core Democrats want to attract in 2020 if they have any hope of unseating Trump. Should the House show that under Democratic leadership nothing gets done except investigations intended to placate a liberal base, the centrist core will abandon them in 2020. There are, actually, a lot of issues where some compromises can be achieved:
- Infrastructure – The issue isn’t the need; it’s how to pay for those needs.
- Drug pricing – Both the White House and Democrats supports Federal efforts to rein in drug price inflation.
- Regulating Social Media – Again, both sides see abuses. What can be done and what should be done remain open questions.
- Immigration – Republican voters labeled this their single biggest issues. Democrats understand a desire for strong borders and tighter control but they would like to see a little more empathy. That includes a path to citizenship for Dreamers. There was an apparent agreement at one time to allow the Dreamers a path in exchange for funding for a wall along our Southern border. That just might come to fruition in this coming Congress.
- Spending control – While Democrats have a wish list of social spending programs, they won’t get anywhere, at least for the next two years. The first fiscal fight of note will be the extension of the debt ceiling, which was suspended until March 2019 so as not to interfere with the election. Democrats are certain to try and bargain for something in return for extending it while Republicans are going to say what all incumbent parties say, i.e. the debt ceiling debate shouldn’t be politicized. Perhaps this debate, more than any other, will show what power to persuade the Democrats actually have for the next two years.
- Foreign affairs – While it might appear that the House would have little control over foreign affairs, fiscal matters begin there. Without funding, even the White House has limited options.
- Debt and Deficits – While Democrats are often pictured as big spenders and Republicans portrayed as conservatives, the truth is that everyone wants to spend and few want to pay fully for what they spend. That produces trillion dollar sized deficits. The President, the House’s Freedom Caucus, and at least a few members of the Senate, profess some degree of fiscal discipline. The danger is that the sum of all these don’t add up to a majority. Escalating spending might help GDP growth in the short run but too much debt eventually leads to catastrophe.
- The Presidential Tweets – It isn’t like Mr. Trump to act conciliatory when he is mad. Will he use his bully pulpit to pressure House leadership to act as he wants? Almost certainly, the answer to that is yes. But unlike on The Apprentice, he can’t fire anyone in the House. Will his tweets be part of a successful negotiation or will it further split the nation apart? The answer could be yes to both.
With all that said, the likely legislative path for the next two years will be gridlock. Yesterday can also be seen as the preamble to the 2020 elections. One can look at that in two lights. Favoring the Republican side, Democrats have a long history of overplaying their hand. The shift in the House was largely a response from suburban districts that were repulsed by Trump’s behavior more than his policies. State by state, red or blue, Democrats picked up House seats in big city suburbs. Those areas are and will be the party’s strength over the next two years. While these districts have been leaning left for many years, they are not populated with a majority that favor a far left economic agenda. On the other hand, rural districts were decidedly pro-Trump. If anything, the elections show that he expanded his base. What we learned about 2020 is that the election is likely to be decided by a few key states, Florida, where it appears Republicans won narrow victories in both the Governor and Senate races, and in a swath of the country from Pennsylvania to Minnesota where Trump surprised everyone in 2016. There the message for Republicans wasn’t quite as strong last night. They lost many House races in districts Trump won in 2016. These states, Pennsylvania, Wisconsin, Ohio, Michigan and Minnesota, plus Florida, will be the true battleground for 2020.
Elections are not the only story this week. The Federal Reserve’s open market committee meets today and tomorrow. No one expects any action but there will be a lot of focus on Chairman Powell’s post-meeting remarks. Given recent economic strength, I doubt he will be ambiguous about a December rate hike although there are a few, including President Trump, who would like to see some equivocation. Instead, there will be a lot of questions trying to see if Powell will move from his stance that the course of rate increases is to get to about 3% (i.e. four more rate increases over the next year) with a possibility of a few more should the economy stay strong accompanied by slowly rising inflationary pressures. Mr. Powell could well stay pat with his prior stance, which spooked markets in October while emphasizing his willingness to adjust policy to the data. Said slightly differently, I would expect Mr. Powell to be a bit more dovish in tone without changing his basic plan of attack. All markets really want or have any reason to expect is just that; a willingness to let the data create the path and not some preordained road map.
In sum, this is an important week but it is not over. The elections sealed the deal of a split Congress, one that is likely to do very little over the next two years but one that will play a big role in how the 2020 Presidential campaign will play out. Democrats need both a candidate and a message. At the moment, they have neither but there is a long time between now and November 2020. The second, and perhaps to markets, the more important will be the comments tomorrow from Mr. Powell. As long as growth is above 3%, unemployment is low, and inflationary pressures are rising, he is likely to keep on course to raise rates at least 3-4 more times. He is likely to say that while, at the same time, noting that the Fed is always data dependent and will adjust along the way to economic circumstances. This morning markets will celebrate a bit. Whether that celebration lasts beyond tomorrow morning will hinge a lot on what Mr. Powell has to say.
Today, Emma Stone turns 30. Ethan Hawke is 48. Sally Field is 72.
James M. Meyer, CFA 610-260-2220
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