The Republican wave that everyone expected in the American elections on November 8 did not occur. If the final results are not known for several weeks, Joe Biden’s Democrats have retained control of the Senate, while the Republicans would have taken over the House of Representatives. After less than two years in power in Washington, the Democrats will now have to share them. This suggests many blockages between now and the November 2024 presidential election. What impact on the US economy and financial assets?
Blockages and expenditure reduction
Since coming to power, Biden has launched two programs to help the economy, increasing public deficits. The 2021 American Rescue Plan poured some USD 1900 billion into a booming US economy (reopened in the aftermath of the end of pandemic restrictions), pushing consumption to the top and boosting inflation.
To counter it - but also to improve the chances of a Democratic victory in this election - the Inflation Reduction Act (a law on reducing inflation that weighs some 433 billion USD) arrived in August.
A House of Representatives in the hands of the Republicans should change the situation for the future. Fiscally more conservative - especially when the occupier of the White House is hostile to them - and always enthusiastic about the idea of "thirsting for the beast" (depriving the State of resources to force a reduction in its size), they should be against any further injection of funds into the economy, at least until the November 2024 presidential election.
Blockages of any ambitious new policy are to be expected, while muscular tensions around a recent raising of the US debt ceiling are inevitable.
This change comes at a delicate time for the American economy. Admittedly, growth returned in the third quarter, with an annualised gain of 2.6%. Still, very high inflation, the fall in purchasing power (fall in real wages), and the increase in credit will precipitate the challenging year 2023, with a slight growth of 0: only 5% and a real possibility of a recession.
For about two decades, both Washington (through successive stimulus packages) and the US Federal Reserve (through often ultra-expansionary monetary policy) came to the economy’s rescue when it had gone through empty passages.
With the Fed in the middle of the fight against inflation in the current economic climate, it would be up to fiscal and fiscal policy to play.
However, in cohabitation less than two years before the presidential election, the Republicans will not let anything pass in measures likely to support the popularity of Joe Biden. They will then be able to point fingers in a recession.
This will undoubtedly increase the chances of a return of the Republicans (Donald Trump or another) to the White House.
Therefore, the US economy and equity markets will be more left to their own devices and less influenced by politics (whether it be Washington’s decisions or the Federal Reserve’s monetary policy). This will only necessarily displease some, especially those who believe that the omnipresence of the Fed in the markets distorts prices.
However, in a major glitch, the economy and markets may have to recover on their own or almost on their own. Fortunately, whether in terms of technology, energy, finance, or even military, the United States has assets that no other country has, and Washington does not hesitate to use them to achieve its ends.
So we encourage you to have exposure to the world’s largest economy in any diversified portfolio.
The bond market will have to wait
Of course, bond markets should welcome the prospect of a healthier monetary policy. 2020 and 2021 were marked by substantial budget deficits in the United States, at 14.9% and 16.7% of GDP, respectively.
Enough to push US public debt to 137.2% of GDP in 2021, against 106.8% «barely» in 2019. For the current year, the budget deficit should still exceed 6% of GDP. Consolidation is, therefore, necessary to improve the debt trajectory of the United States and reassure investors. A Republican-controlled House is an excellent way to do that
But the reality is complex: if it is certain that the Republicans are opposed to any additional public spending, it is also true that they will be opposed to Biden’s corporate tax hike or any other tax hike. It is supposed to balance the public accounts and pay a large part of the inflation reduction act.
Without them, the trajectory of the American public debt may further deteriorate. Should we invest in US sovereign debt at this stage? We think so. The 10-year rate of 3.9% makes it an attractive investment in any diversified portfolio.
A global impact
It is not only at the level of public finances that the blockages are likely to succeed. The Republicans are reluctant to introduce new rules or constraints that might affect business and the economy. They also care less about what the rest of the world thinks. Therefore, ESG issues and the energy transition will certainly not be among the priorities of a House of Representatives in the hands of the Republicans. With them, it will be, in the best case, immobility.
Another significant unknown is the conflict in Ukraine. Many elected Republicans believe that the support sent to the country should be reduced, while Donald Trump calls for negotiations to end the conflict.
Europe may well be caught in a situation where it either accepts a negotiated solution or has to assume most of the military and financial support in Kyiv. These elections can therefore determine the outcome of the conflict and its duration.