US Midterm Elections

1) Democrats take the House, Republicans retain the Senate

At FiveThirtyEight, the statistical analysis site, Republican odds in the Senate were 83.2% last week, they have shifted slightly higher to 84.5%. Democratic chances in the upper house were 16.8%, they have dropped to 15.5%. The average Republican gain is 0.7 seat. Like last week these percentage shifts have taken place as new RealClearPolitics averages give the Republicans one fewer Senate seat. Last week the Republicans were projected to win two new seats gaining North Dakota and Missouri, while losing no contests resulting in a margin of 53 to 47. The two Plains states remain Republican this week but now the Republicans lose their current seat in Arizona giving them one net pickup and a Senate at 52 Republican and 48 Democrats.

Of the six Senate seats considered toss ups by RCP, two are led by less than one point, Arizona and Indiana, three, Missouri, Nevada and Florida, have a candidate ahead by two points or less. All five states are within the margin of error for their polling averages and are statistically tied. Only in Montana is there a lead beyond the error margin. The movement that we saw last week toward Republican candidates in six states, Indiana Missouri, Arizona, Michigan, Nevada, and North Dakota, has been reversed in four, Arizona, Nevada, Michigan and Indiana with the completion of new polls. Both RCP and 538 award the Republicans one additional seat at 52 to 48. The current Senate is 51 Republicans and 49 Democrats.

Market impact: This remains the favored outcome, has been so for most of the campaign and as such is largely priced into the markets. A Democratic House and Republican Senate, with narrow majorities in each would lead to legislative and policy gridlock. In the current atmosphere it seems unlikely that the sides would be able to cooperate on anything more than the most necessary funding and operational appropriations. The administration would not be able to advance its economic approach by making the tax cuts permanent or institute other initiatives but their beneficial effects would remain to encourage growth. Trade and regulatory policies would continue as they are with the potential for an agreement with China available to boost growth. There is no policy reason that a divided government would damage economic performance.

Currencies: The dollar should remain favored as its economic, rate and policy supports will not be affected by the change of power in the House. American economic growth and the Fed’s rate policies have been the chief factors in that success. Of greater potential impact is the aging of this scenario and new developments in Europe. The euro and sterling will remain dominated by the outcome of the Brexit negotiation. If, as expected, there is an eventual agreement both will benefit with the larger boon to the pound. The Italian budget will continue to drag on the euro until a face saving solution is found that permits Rome to spend on its economy. Commodity currencies and emerging markets are tied to US and global economic expansion. If the slowdown in China becomes more pronounced it will have a larger impact than the US election. Conversely a trade deal between Washington and Beijing will probably do more to heal growth concerns around the world than any decision of the US electorate.

Equities: The prime concern of equity markets will be the impact of the election on US growth. Legislative gridlock is historically good for stocks and the economy can be expected to maintain its current pace of 3% and more expansion. With no new policy initiatives the markets will soon be able to answer the question whether the tax cuts and regulatory reform have moved the economy to a long term period of faster growth or simply provided a surge of consumer and investment spending that will subside and take growth down with it. Equites will move accordingly.

Fed policy and credit markets: The Fed’ rate projection of 3.25% in the Fed Funds at the end of 2019 included a decline in GDP to 2.5% next year. The election will not alter the Fed’s view unless the US economic performance changes substantially. The gradual inclination of US interest rates higher rates should continue.

2) Democrats take the House and Senate

Democratic odds in the House from FiveThirtyEight have improved to 85.2% from 84.5% but their chances in the Senate have fallen to 15.8% from 16.8% last week. Their odds of a double takeover have fallen slightly since last week. RealClearPolitics agrees on the House with 203 Democratic likely seats, 196 Republican and 36 toss ups. The average gain of 26 seats would give the Democrats them 229, a majority of 11. On the Senate side the Republicans have lost one seat to 52 but remain the favorite.

Market impact: The immediate market reaction would be negative as Republican economic policies which have improved growth, employment and wages would be threatened. It would be markedly harder for the administration to fend off Democratic initiatives without the aid of at least one House of Congress and the President’s international position would be concomitantly reduced. Beyond the initial impact much would depend on the path chosen by the Democrats. Confrontation, investigation and perhaps impeachment could be very damaging to economic growth. If the US suffered from the political atmosphere in Washington that could easily impact growth around the world.

Currencies: The dollar would be penalized almost immediately on the assumption that the conflict between President Trump and a Democratic Congress would paralyze policy in Washington and could quickly begin to impact the economy. This effect would likely rule all of the trading relationships of the US currency and at least temporarily take precedence over local considerations.

Equities: The worst outcome for stocks, immediately lower on reduced economic expectations. Longer term results would, as in the general market view, depend on the governing path chosen by the Democrats. Confrontation would be punished and cooperation rewarded.

Fed policy and credit markets:  A double victory for the Democrats would also be the most problematic for Fed policy. The tightening cycle requires an economy growing fast enough to support the increases without stalling. The impact of the larger Democratic sway over economic policies would take time and it might not be negative, depending on the choices, but the immediate assumption would be reduced economic growth. The Fed might be reluctant to highlight its concern by declining to hike in December but until the effect of the political confrontation in DC on the economy was known, policy would become more cautious. The chance of three 25 basis point increases in 2019 would drop sharply

3) Republicans keep the House and Senate

FiveThirtyEight has this outcome at the smallest odds though with a slight gain from last week. The Republicans have a 14.8% chance of keeping control in the House down from 15.4% last week. Their Senate chances have improved to 84.2% from 83.2%. Thus their overall average is slightly better though still below the Democratic odds for double control RealClearPolitics gives the House to the Democrats with an average gain of 26 seats out of 36 in contention. This is but three more than the 23 needed for the Democrats to seize control. A switch of a very few number of seats could keep the House Republican. That possibility is a good deal more likely than the opposite one where the Democrats obtain the Senate thus the higher standing for this outcome. In an election as close as this the imponderables of motivation and emotion are large and almost impossible to chart. Democrats have been campaigning for this election for two years, has their passion waned? Has the Kavanaugh bump for Republicans faded? What effect will the booming economy have? The most important imponderable is the same as it was in the 2016 presidential election. Trump’s voters, Mrs. Clinton’s “deplorables’ the ones who put the President over the top in the old industrial Mid-West are not standard Republican partisans. They don’t fit normal voter distribution categories and they are particularly difficult to poll. Can their vote be transferred from the President to enough local candidates to elect a GOP Congress? That is clearly the logic behind Mr. Trump’s extensive rally tour of contested states and districts. It was the technique that won the Presidential election, will it work again?

Market impact: Unified control of Congress would revive Republican plans for the economy. Further tax cuts, another approach to the health insurance market and Obamacare, immigration reform, regulatory reductions and other items will be on the agenda. Republican economic policies would be viewed by the markets as an assist to economic growth though there will be doubt until proven, as to whether the US economy can expand much faster than its current rate.

Currencies: The dollar would gain modest and probably temporary support if the US economy improves, things in the rest of the world being equal. This will be tempered if the global economy also revives, particularly China. A victorious Trump administration would have a stronger negotiating position in its trade dispute with the mainland and that will make a deal more likely not less. Commodity and emerging market currencies will eventually benefit from the change in scenario from a declining Chinese economy to renewed growth.

Equities: The Republican focus on economic growth would provide stocks with new life. Over time the assumption of better US performance would need to be backed by statistics but stocks would have an immediate and substantial boost from a Republican triumph.

Fed policy and credit markets: The Fed program of normalizing US interest rates would be solidified by Republican retention of the House and the possibility of enhanced economic growth. The governors are not raising interest rates to calm an overheating economy or to forestall near-term inflation but to return rates to a more historical relationship to the economy. Chairman Powell and the board intend to provide a cushion for rate reduction in the next recession. As such the greatest risk is slower economic growth that makes rate increases too risky.

The U.S. mid-term election is a contest between the roaring Republican economy and the President Democrats love to hate. Republicans are defending their slim house and Senate majorities against Democrats campaigning almost exclusively in opposition to President Trump. Republicans are running on an excellent economic record and the President’s achievement in enacting most of his campaign promises. Both parties have geographical disadvantages, the Democrats in the Senate and the Republicans in the House; each side claims the other is unfit to govern. Republicans must also contend with the historical disadvantage of the party that holds the Presidency in an off-year election.

Over the entire nation looms the polarizing figure of Donald Trump. Love him or hate him, he is at the center of this election. The electorate is particularly volatile this year. The combination of Mr. Trump in the White House and the de facto head of the Republican Party, whose combative style contrasts with a traditional and successful conservative agenda, has generated intense opposition from the Democrats and allied organizations. The contentious nomination of Brett Kavanaugh to the Supreme Court, now approved, has excited passions and voting intentions on both sides making the elections difficult to score.