Investors have little fear of congressional gridlock. Markets have taken this week’s US midterms in their stride, and not just because the results were largely as they expected. The US stock market has a strong historical record of rising in the 12 months after midterm elections — including those in which the presidential party has lost one or both houses of Congress.
Investors have little fear of congressional gridlock. Markets have taken this week’s US midterms in their stride, and not just because the results were largely as they expected. The US stock market has a strong historical record of rising in the 12 months after midterm elections — including those in which the presidential party has lost one or both houses of Congress.
Yet the market may be underestimating the extent to which this election could mark a shift. For investors, the first half of Donald Trump’s four-year term has been largely dominated by market-friendly fiscal stimulus and deregulation measures. As the 2020 presidential election approaches, the Republicans’ constrained ability to push legislation through Congress may force Mr Trump to be more aggressive in areas, such as trade and foreign policy, where he has more autonomy. That could be negative for markets and for the broader economy.
The direct economic dangers of a more rancorous and partisan politics are limited, beyond the risks of government shutdowns caused by brinkmanship over the federal budget.
An attempt to impeach the president looks unlikely. Democratic efforts to probe Mr Trump’s finances or relations with Russia may create sound and fury, but with little effect on the real economy.
Those fundamentals, however, are starting to slow. US growth is already set to fall from current super-charged levels in the next two years; the boost from last November’s tax cuts is likely to peter out by mid-2019. Chances of a further fiscal stimulus now look small.
One potential boost could come through an infrastructure package, an initiative that enjoys, in principle, bipartisan support. But the rival parties disagree sharply on how to fund such a plan. The Democrats, moreover, will be reluctant to support measures to bolster the economy for which Mr Trump could take credit in the 2020 campaign — though they must weigh that against the risk of being portrayed as saboteurs who undermined growth.
Watching the economy slow while lacking power to reverse it is likely to enrage the president. One target of his ire will be Jay Powell, the Federal Reserve chairman, whom Mr Trump has already called “crazy” for raising interest rates. But it is probably too late for Mr Trump to change the Fed’s composition. And however uncomfortable Mr Powell’s life becomes, the signs are that he will stick to a prudent and conventional monetary policy. The Fed remained on track, after its meeting on Thursday, for a December rate rise, giving a bullish verdict on the economy.
One silver lining for markets could appear if growth decelerates by such a degree that the Fed slows or curtails its programme of rate rises. That could help extend the era of strong corporate earnings growth.
But Mr Trump’s mounting domestic frustration is likely to find vent in further trade protectionism and confrontation with foes, such as Iran. The president seems more likely to up the ante with China over tariffs — popular not only with his own political base but with many Democrats — than seek a deal with Beijing that could deliver a pre-election economic dividend.
The risks of the tariff tussles escalating into a full-blown international trade war — or into a broader US-China stand-off— were already a factor in US and international market weakness last month. The likelihood is that Mr Trump will become even more aggressive, at home and abroad, in the next two years. This is the reality to which investors must now adjust. The midterm elections have only just finished. But the 2020 presidential campaign is already under way.
