US Macro: What the midterms mean for growth, the Fed, and markets

Senior Economist, Bill Diviney, explained that with the Democrats winning control of the House, and Republicans retaining control of the Senate, the outcome of the midterm elections was as they and markets had expected.

However, he argues that the outcome now paves the way for the growth slowdown that we have had for some time as our base case scenario.

Key Quotes:

"At the current growth pace of 3-4% annualised, the economy is firing on all cylinders, and growing well above potential (the Fed’s estimate is 1.8%). From early next year, we expect momentum to cool, driven by slowing investment. The projected increase in government spending will likely keep growth somewhat above potential for a time.

However, by Q4 19 we expect annualised growth to dip below 2%, and to continue at that subdued pace into 2020, as the fiscal boost eases. The main risk scenario for us would have been a Republican victory in both the House and the Senate, which would likely have meant further fiscal stimulus and a prolonged ‘boom & bust’-style economic cycle. With Democrats now controlling the House, we think it will be much harder for the President to push through further significant tax or spending changes.

While Democrats may favour more infrastructure spending, we suspect any moves on this front would be as fiscally neutral as possible, to avoid supporting the President’s prospects ahead of the 2020 elections.

With growth momentum slowing as 2019 progresses, and leading indicators next year likely to suggest a further slowing in 2020, we expect the Fed to pause in its rate hike cycle after June. This implies one fewer rate hike in 2019 than the three hikes that the current FOMC ‘dots’ projections suggest. In line with this, we also expect bond markets to begin pricing in the end of the rate hike cycle in the first half of 2019. As such, we expect the 2y yield to peak at 2.95% in Q1 2019, while for the 10y, we believe rates have already peaked, and will dip below 3.00% by Q2 2019."

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