US Midterm Election Outlook:
- Unless gas prices fall further and US inflation returns sharply, Democrats are likely to lose control of the House of Representatives, at least to Republicans.
- The prospect of a return to gridlock in Washington, DC has profound implications for the Federal Reserve and the US dollar.
- The Federal Reserve could quickly become the ‘only game in town’ again, as it did from 2011 to 2016 and again from 2019 to 2020.
Recommended by Christopher Vecchio, CFA
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Gridlock back in DC?
In How record inflation will affect the US medium termIn this article, we explore how record inflation could affect the US midterm elections this fall. We concluded that unless gas prices fall further and the US inflation rate declines sharply in the coming weeks, it is likely that Democrats lose control of the House of Representatives, at least to Republicans, Bringing a divided Congress and gridlock back to Washington, DC.
Such developments would have profound implications for both US fiscal and monetary policy in the coming years, and would have a direct impact on U.S. DollarUS Equity, US Treasury, gold prices, oil prices, and cryptocurrencies. All of these effects will flow primarily through the Federal Reserve.
turn back the clock
A walk down memory lane is essential to understanding the potential earthquakes – both fiscal and monetary – of US policy in the coming months.
In 2010, after former US President Barack Obama and Democratic majorities in the Senate and House of Representatives passed The Affordable Care Act during the Global Financial Crisis, there was a wave of backlash from voters across the country. Several rounds of federal government spending were announced to help stimulate the economy, save the banking system, the housing market and the automobile industry.
But the backlash was fierce as most American households continue to face financial difficulties and a weak labor market. The US unemployment rate was still close to double digits as the housing market was in shambles. The Democrats lost control of the House of Representatives in the 2010 US midterm elections. Gridlock arrived in Washington, D.C., as a divided Congress refused to pursue more government spending.
Gridlock was the defining feature of the next few years. Republicans, buoyed by their gains in the 2020 US midterm elections, called for budget austerity to govern government spending. Tension ensued, forfeiting the budget, and in August 2011 the US lost its AAA credit rating to Standard & Poor’s. By 2014, in the middle of former US President Obama’s second term, Democrats lost control of the Senate.
While the federal government was effectively paralyzed by a divided Congress, and then by a Democrat in the White House, while Republicans controlled all of Congress, the only city in the city to help provide support for the American economy. There was only one game: the Federal Reserve.
Fed policy during gridlock
From 2011 to 2016, a paralyzed federal government unable to pass any additional stimulus left the Federal Reserve with few options: slashing interest rates and the recovery of the nascent post-global financial crisis; Or keep interest rates near zero and hope the US economy continues to improve. The Federal Reserve chose the second option:
The period from 2011 to 2016 was not the only time in recent years with a standoff in Washington, DC. The same can be said about the period from 2019 to 2020 during the only term of former US President Donald Trump. Limited federal government spending by the coronavirus pandemic meant the Federal Reserve had to back out of its interest rate hike cycle, cutting rates to help prop up asset prices. Even as Congress passed its coronavirus stimulus package, the Federal Reserve lowered its key rate by 0.00-0.25% while resuming asset purchases.
Implications for US Midterms
If the 2022 US midterm election delivers a stalemate in Washington, D.C.—Republicans control just the House or both chambers of Congress while a Democrat is in the White House—it means the Federal Reserve will quickly be the only game in town once again. Will become.
Should the U.S. inflation rate ease over the next few months, which has nothing to do with Congress’s composition, it could mean the Federal Reserve may come back to prevent a more significant economic downturn, something it already has. It’s on his radar. The US economy has contracted for two consecutive quarters.
If the Federal Reserve shifts gears and moves toward cutting interest rates, and to the extreme, reinstate asset purchases once again to encourage investors to change their risk preferences (thereby lowering the yield on safer assets). The impact will likely be no different from what happened from 2011 to 2016 or 2019 to 2020. Such a shift reflects a weaker US dollar; lower US Treasury yields; high gold prices; high oil prices; high cryptocurrency value; and higher float by US equity markets.
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— Written by Christopher Vecchio, CFA, Senior Strategist