US midterms: The end of the spending spree?

Author: Forex Live | Category: Education

The potential impact of the US midterms on markets

OBX
Many political analysts have remarked on how much spending the Biden Administration has been and is trying to get through from day 1.

In fact, so far, Biden has secured more spending in his first six months than any other president in history, even when adjusted for inflation. And analysts expect there to be an additional $4.5T in spending approved by the 27th of September.

Considerable government spending in the context of the covid pandemic is anticipated. However, there is another dimension that has implications for the markets further down the road, and that is the political reality.

Getting ahead of the moves

A lot of traders are probably not thinking about the next round of elections in the US at this point. They are, after all, over a year away and a lot can happen before then.

But the political planners in the White House are considering the midterms, and that has implications on their policy decisions. It might also explain why many people in Washington are more confident about the temporary nature of inflation than analysts in New York.

As a general rule, the party in power loses support during the midterms. There are several explanations for that.

Principally, the Presidential election has different coverage, and the voters have different motivations when going to the polls. It doesn't always mean that the Congress switches parties, but it has happened quite a lot in the past.

Where this is going

The thing is, during the last election, Democrats managed to win control over Congress by the bare minimum. They lost seats in the House but managed to keep control with a majority of just 5 members.

The Senate is split evenly, allowing for the Vice President to cast tie-breaking votes. Nonetheless, Democrats secured that even split with highly controversial elections in Georgia, with significant influence from Donald Trump.

Next year, all House members are up for reelection, as well as one third of the Senators.

Most importantly, one of the senators from Georgia is also up for reelection. If Democrats lose just one Senator, and 6 House seats, then Biden will have to deal with two years of an opposition Congress.

So, in the fall, virtually all the analysis and polling suggest that will happen.

A potential reversal?

Usually, the only way to salvage the midterms is for the President to be very popular, and boost his party's candidates.

However, after the Afghanistan debacle and economic concern over the delta variant, that seems unlikely for now. Unless Biden finds some unexpected way to gain popular support, the historic trend for a switch in party dominance in Congress is highly possible.

Biden's political team was evidently well aware of that, and understood they had a relatively short window to get their administration's priorities through. This means "front-ending" as much of their spending as possible, since historically a Republican Congress is very unlikely to increase spending for a Democrat President.

Getting spending under control is a different matter

Of course, dissenters might point out that last year under a Republican President, the US' deficit as a percentage of GDP rose to the highest level since WWII.

Even before the recession, back when Republicans controlled the Presidency and Congress, spending increased at pretty much the same rate as under Obama.

The thing is, Republicans often suddenly find their fiscal responsibility backbone when they can use it to oppose a Democrat President's policies. While the Biden Administration might get some increases in spending along bipartisan lines, there is no chance of getting partisan spending through, should the Republicans win in 2022.

What it means for the markets

As a measure of comparison, Republicans are supporting a $1.0T infrastructure package, while Democrats are seeking to pass an additional $3.5T in the latest financing round.

A Republican Congress, therefore, doesn't mean that spending won't increase, just not as fast.

With the Biden Administration trying to compress almost four years of political spending into the first year to ensure it gets passed in time, it's natural to expect a soaring deficit right now.

However, it's likely that next year, the Administration will dial back on their spending requests, and try to burnish a more fiscally responsible image going into the election.

Less spending, but less inflation?

The first quarter of this year saw the highest amount of US government spending ever. But since then, it has fallen.

Current legislation suggests that spending will decrease next year. Even with the $4.5T in spending planned, the increase would be relatively small. In fact, economists expect it to be parceled out over the coming years.

The largest increase in government spending during the pandemic was for "job protection programs" which significantly increased the disposable income of Americans. This is naturally likely to push inflation higher. Those programs are also coming to an end this month.

In the end, however, it is still way too early to know for sure what a Republican Congress will do, if it even happens. Not even Kevin McCarthy has said what he would do as Speaker of the House at this point, especially since he hasn't even started running.

This article was submitted by Orbex.
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