How will the US midterms affect global markets? - J.P. Morgan Asset Management
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How will the US midterms affect global markets?


The result of the midterms may have implications for fiscal policy—and therefore the US expansion.

Nandini Ramakrishnan


The outcome of the midterms is hard to predict, but the results will affect the outlook for fiscal and trade policy. If the Republicans retain the House, we could see an extension of the current fiscal stimulus to avoid a fiscal cliff ahead of the next Presidential election. If the Democrats take the House, the Trump administration may instead increase its focus on trade policy.

In brief
  • The US midterms are approaching (6 November), and while it is hard to predict the outcome, there will be market consequences that are worth considering today. The result of the midterms may have implications for fiscal policy—and therefore the US expansion—and also for the administration’s foreign policy, which has particularly upset the outlook for the Chinese economy in recent weeks.
1. Tax cuts 2.0?

The US economy is currently buoyed by an enormous fiscal stimulus, including a cut in national corporate taxes from 35% to 21%, personal income tax cuts and childcare credits. Together, for 2018, these measures have contributed to US GDP growth of nearly 3% year on year and S&P 500 earnings per share growth of more than 20% on current estimates.

But on current plans, these fiscal tailwinds turn to an almighty fiscal headwind in 2020 (Exhibit 1). Given that 2020 is the year of the Presidential election, one might expect the current administration may want to push out this fiscal cliff for another year, which could potentially extend the US cycle (and thus also have implications for US monetary policy).

The administration’s ability to extend the fiscal stimulus depends on the whether the Republican Party maintains sufficient authority to pass such legislation.

EXHIBIT 1: US MIDTERM ELECTION POLICY IMPLICATIONS

Source: (Left) IMF, Thomson Reuters Datastream, J.P. Morgan Asset Management. Cyclically-adjusted primary balance is defined as the fiscal balance adjusted for the cycle, excluding net interest payments. It is a commonly used measure of discretionary fiscal policy. Projections are based on IMF staff assessment of current policies. Short-term fiscal policy assumptions are based on officially announced budgets (adjusted for IMF staff macroeconomic assumptions), whilst medium-term fiscal projections incorporate policy measures that are judged likely to be implemented. US projections incorporate the effects of tax reform as well as the Bipartisan Budget Act of 2018. (Right) BEA, China National Bureau of Statistics, Office of the US Trade Representative, Thomson Reuters Datastream, US Commerce Department, US Federal Register, J.P. Morgan Asset Management. Auto tariffs includes auto parts. Past performance is not a reliable indicator of current and future results. Guide to the Markets - UK. Data as of 30 September 2018.

2. Chinese import tariffs 2.0?

The administration’s ability to alter trade policy is less contingent on the outcome of the election. The US Constitution assigns authority on foreign trade to Congress; under the Trade Promotion Authority,1 though, Congress has given the president power to negotiate trade treaties and then submit them for approval to Congress. Discussion on some auto tariffs and on trade agreements with Europe, Mexico and Canada are being processed under this framework. The approval process depends on the president’s support in both the House and the Senate. But an executive (presidential) order can be used if the proposed tariffs deal with a matter of national security (Section 232) or unfair trade practices (Section 301). This means support from Congress is not required for implementation.

The administration’s trade measures have already gone beyond what most analysts expected at the start of the year. Tariffs have been imposed on solar panels, washing machines, aluminium and steel, and on USD 250 billion worth of goods imported from China. Many—including us—underestimated the extent of the escalation largely because it was assumed that such tariffs would serve as a self-inflicted wound for the US economy; that the cost of higher prices would fall on US consumers and businesses. But the administration appears to expect a self-inflicted boon, with production and jobs being returned rapidly to the US. Time will tell which thesis proves correct, but in the near term higher tariffs are likely to stoke the inflationary pressures that are already slowly building in the US economy.

3. Possible 2018 results

As a reminder, the midterms are the elections that occur in the middle of a president’s four-year term. 35 seats in the Senate and all 435 seats in the House are up for re-election in 20182. The 435 seats in the House are based on the districts within the states, and allotted by population.

Generally, policy proposals must go through both the Senate and the House before becoming law. Both bodies of Congress (the Legislative branch) have areas of focus and power, as noted in the table opposite (see Exhibit 2).

Current polling suggests that the Senate will remain a Republican majority, while the Democrats may be able to take the House.

Senate: 51 of the 100 seats is considered a majority. The current composition is 51 Republicans and 49 Democrats3. Of the 35 Senate seats up for re-election, 26 are currently held by Democrats. This means the Democrats will need to hold on to those 26 seats and gain 2 more to have a Senate majority. This appears unlikely based on current polling.

EXHIBIT 2: BRANCHES OF THE US GOVERNMENT

House: 218 of the 435 seats is considered a majority. The House would shift to a Democrat majority with a gain of 25 seats from the 2016 composition. Since all House seats are up for election, there are no guarantees, but current analysis suggests that the Democrats will take 180-190 seats and the Republicans will win 135-140. That leaves 110-115 seats, for which the outcome is less clear. Within those 110-115 seats, today’s predictions suggest 20-30 will likely go to the Democrats, 60-70 will go to Republican candidates, and the remaining 10-20 seats are truly up for grabs.

EXHIBIT 3: EXPECTED BREAKDOWN OF HOUSE SEATS

Source: FiveThirtyEight (fivethirtyeight.com), J.P. Morgan Asset Management. Data as of 2 October 2018.

Taking all this into account, Nate Silver’s FiveThirtyEight currently suggests around an 80% probability that the Democrats will take enough seats to have a majority. History tells us that the incumbent president’s party tends to suffer a loss of seats in the House in the midterm elections, as a sort of protest vote (see Exhibit 4). The scatter plot shows that given the president’s current approval ratings of 40%-45%4, one might expect a swing of 20-30 seats.

EXHIBIT 4: MIDTERM HOUSE SEAT SWINGS AND PRESIDENTIAL APPROVAL RATINGS

Source: The American Presidency Project – The University of California, J.P. Morgan Asset Management. Data as of 2 October 2018.

We are however mindful that in several high-profile ballots of recent years—Brexit and President Trump’s election among them—the polls have failed to predict the final outcome. It is thus very hard to say with any degree of confidence whether the Republicans will retain a majority in the House.

If the House is lost to the Democrats, it may be hard for the Republicans to alter the course of fiscal stimulus, meaning a downturn in 2020 looks a distinct possibility. Such a result may also mean that the administration focuses its efforts on trade policy, which could further rattle global markets.


1 Trade promotion authority (TPA), sometimes called “fast track,” refers to the process Congress has made available to the President for limited periods to enable legislation to approve and implement certain international trade agreements to be considered under expedited legislative procedures. (Source: Congressional Research Service).
2 Excluding Senate special elections.
3 Independent senators Bernie Sanders and Angus King are treated as Democrats because they caucus with that party.
4 FiveThirtyEight: fivethirtyeight.com.

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