A very short and insightful read by the folks at Morgs on the possible impacts that this year's Midterm Elections may have on markets.
Policy Path #1 Republicans Win Control of Both Houses
Republicans need to gain four seats to take the House. Meanwhile, a 50/50 Senate means they need to net one seat to gain control. With such relatively low barriers to victory, prediction markets recently implied a 74% probability that Republicans would win both chambers and control of the legislative agenda.
Market Impact: This outcome would make major new spending initiatives unlikely to materialize over the next two years, while fiscal policy would remain reactive rather than proactive. “In this scenario, certain legislative priorities are immediately off the table–like tax increases or investments in clean energy–while others become much more difficult to achieve,” says Zezas. Moreover, if Republicans won’t have the ability to push their policy preferences past the White House, investors should prepare for gridlock.
Policy Path #2 Split Control of Congress
While the Democrats are significant underdogs in the midterm election, there is a chance they could retain control of at least one chamber. Prediction markets recently gave a 19% probability of a Democratic Senate and Republican House and a 4% chance of Republican-led Senate and Democratic-controlled House
Market Impact: This scenario could provide a little room for new legislation in areas where significant bipartisan consensus already exists, such as technology and crypto regulation, prescription drug pricing and energy investments. However, the outcome would be narrower in scope than what could be passed in a Democrat-only scenario. Fiscal expansion would come only as a reaction to deteriorating economic conditions or an external shock to the economy, something we saw in the passing of the 2020 CARES Act and subsequent fiscal aid measures.
“This bipartisan action will likely be more limited in reach than what is possible under a unified government outcome, narrowing lawmaker ambitions as well as potential market impact,” Zezas says.
Policy Path #3 Democrats Retain Control
Polls and historical precedence indicate that Democrats are unlikely to sweep both chambers in 2022 and have a 10% probability of retaining control. Still, with a favorable Senate map and a redistricting process that protected more Democratic seats than originally anticipated, any major event in the run-up to the election could motivate turnout and give Democrats a narrow win.
Market Impact: Democratic control of both houses would create the smoothest path to legislation likely to impact the market. However, the gap between far-left and center-left Democrats in Congress means legislation would have to be moderate enough to gain widespread support. The most likely outcome of this scenario would be additional fiscal stimulus in the form of a slimmed-down version of the $3.5 trillion Build Back Better agenda, paid for with tax increases on corporations and wealthier people.
“We believe that these hikes can plausibly be paired with the most popular pieces of the rest of the Build Back Better Act,” says Zezas. “While the entire initial proposal would likely not have sufficient support, popular provisions such as climate funding are likely to be pursued in this scenario.”
