The 2022 U.S. Midterm Elections – What’s Next?
This year’s US midterm elections arrived at a precarious economic moment amid rampant inflation and recessionary fears. The results of the election will not likely cure the macroeconomic issues; however, the market has usually performed better in the six months following a midterm election than it did in the six months leading up to it. With equities already underperforming for an average midterm year, will the market react favorably or unfavorably to the midterm results? Or will the election results that saw less-than-expected GOP momentum have a muted impact on investor sentiment?
Historically, midterm elections in a president’s first term have led to opposing party gains in the legislature, and this held true for the 2022 election. The Republicans were not able to engineer the landslide they had hoped for, but the GOP is poised to gain a majority in the House. The Democrats, meanwhile, held onto control of the Senate, with a runoff in the Georgia senate race set to determine the final, razor-thin result. We are therefore heading for a divided government until 2024. President Biden will serve out the rest of his first term largely consigned to govern by executive order, which is unlikely to lead to any enduring reforms.
Financial Consequences of Divided Government
In the short-term, the 2022 US midterm elections will not likely move markets or reverse bear-market trends in any material way. The overall direction of the market will be driven by inflation and the Fed’s current rate-hiking cycle for the foreseeable future. However, elections always have consequences, and the small shift in power will have some meaningful economic impacts.
Once the GOP retakes the House, no major legislation or spending bills are expected to go through congress for the foreseeable future. Markets may view this positively, as it will force Biden to exercise fiscal restraint and hopefully lead to an improvement in the budget deficit and debt-to-GDP ratio. Generally speaking, investors like stability. So, if congress is in gridlock, fiscal policy will likely not change – meaning that markets might rally in the long-run.
Possible Fed Pivot
A contractionary/stand-still fiscal policy as a result of divided government may help the Fed scale back on the extent of their hikes. If the Fed tapers its rate-hiking cycle under the argument that fiscal policy is no longer expansionary and no longer placing upward pressure on inflation, markets will likely take off and won’t look back.
Recession will Run Riot
On the other hand, recessionary headwinds loom large. When the recession does eventually take hold around Q2/Q3 2023, both the Fed and the Treasury will have their hands tied. Usually, during times of recession, there is a fiscal or monetary intervention from either the Treasury or the Fed in order to provide relief to the economy and markets. But amid continued inflation and a split government, neither the Fed nor the Treasury will have any policy tools in their arsenal to come to the rescue. The Fed’s fight against inflation will necessitate at least the maintenance of higher rates, and a GOP-lead House won’t advance any new spending bills.
Debt Ceiling Politics
Once again, the ‘full faith and credit of the United States government’ will come into question, as debt-ceiling politics are set to resume in early 2023 after Republicans retake the House and the debt ceiling deadline approaches. There’s little doubt that House Republicans will hold hostage the raising of the debt ceiling and will demand ransom in the form of spending cuts from the Democrats. Areas most likely to be targeted are programs like Medicare, and Social Security, and various entitlements. Depending on how tense the negotiations become, markets may become rather volatile as we approach the deadline, especially the treasury market. We could see sudden rises in bond yields similar to the recent turbulence in the UK debt market.
Support for Ukraine in Question
Assuming that the GOP will retake the House, several GOP fringe members (like Majorie Taylor Greene) have already made it clear that congress will not pass any new military or financial support for Ukraine (they argue that resources are better spent at home to tackle the effects of a slowing economy).
If the US withdraws or limits its support to Ukraine, it will be a big blow and may alter the course of the war entirely. The Ukrainians have been in the ascendancy in recent months, retaking a lot of lost land and making several well-documented advancements. All this could change; however, if the US decides to pull the plug on support.
A victory for Russia would leave markets somewhat nervous about Russia’s intentions and what it plans to do next. It would almost certainly destroy any remaining hopes of resuming energy imports from Russia in the foreseeable future.
Partisan Politics in a Divided Government
Several prominent House Republicans have already made it explicitly clear that they plan to exact revenge on the Democrats by launching several select committees, investigations, and hearings of their own, namely:
An investigation into the dealings and influence-peddling of the Republicans’ #1 boogeyman Hunter Biden. This could potentially be quite damaging for Joe Biden.
The disastrous withdrawal from Afghanistan.
Fauci’s involvement with the lab in Wuhan and the origins of COVID.
The politicization of the DOJ and FBI (e.g., for raiding Mar-A-Lago, labelling parents attending school board meetings as ‘domestic terrorists’ at the behest of the White House, lack of any investigation into Hunter Biden, etc.).
Potential impeachments of senior Biden administration officials (Homeland Security Secretary Mayorkas, Attorney General Garland) and possibly President Biden himself (over Afghanistan).
The 2024 Presidential Race
The midterm election results only added to the uncertainty of the 2024 presidential race. A landslide victory for the GOP would have potentially spelled the end for Biden’s second term hopes. As his party held onto the Senate and avoided worst-case scenarios, Biden received a modest boost from the elections. However, many in his own party may still not want to him to run again – mostly due to poor approval ratings and his age.
With 300+ candidates who were endorsed by Trump in this mid-term election, the election tested Trump’s grip over the Republic Party. Some commentators in recent months have been arguing that his authority has been waning, and the election results seem to indicate some amount of decline.
Assuming Trump will announce his 2024 presidential run shortly after the mid-terms, markets will certainly be a little skittish as they mull over Trump’s chances to win the Republican nomination and general election in 2024. Markets may not appreciate all the drama that will follow if Trump gets re-elected.
Market Trends
As mentioned above, the impact of the midterm elections will be short-lived on markets. The Energy sector, particularly oil & gas, has already performed well this year due to supply shortages and high energy prices as a result of the war in Ukraine. The GOP is seen as the more fossil-fuel friendly party of the two major political parties, and so American oil and energy companies may see a boost in their share prices as the GOP retakes the House. In any case, global demand dynamics will continue to drive prices. As China continues to reopen, oil prices are expected to revisit $100 per barrel over the next few months, probably by Q1 2023, which is all good news for big oil and big energy.
Overall, the pandemic, rising interest rates and the war in Ukraine have all had much more profound impacts on markets than the midterm elections. There will just be some minor volatility on the headlines as Fed policy and inflation remain the key drivers.
