Gridlock: USA - November 2018
In a nutshell
- Democrats won the House; Republicans won the Senate
- Trump agenda still largely on track
- Record appointment of minority-group representatives, but minority turnout still low.
- May result in some tailwinds for emerging markets
While the outcome of the much-anticipated US midterms last week was a boost to Democrat morale, the political implications tilt more to Congressional deadlock than a broader Democratic participation in the political process. With red prevailing in the Senate there is unlikely to be much change to the Trump administration’s agenda, although getting things done is likely to be much harder – especially in terms of influence to change the direction of Trump’s move to deregulate (business), renegotiate (trade deals) and reform (tax).
In fact, rather than the eagerly awaited blue wave against demagoguery, the outcome was more of a damp, albeit blue, squib.
Republicans took the majority in the Senate with 51 seats vs the 46 seats won by the Democrats; while in the House of Representatives the Democrats gained a majority of 227 vs the Republican’s 198. Most of the seats in the House of Representatives that flipped to the Democrats were in urban areas. A look at the breakdown shows that Republicans went on to maintain the rural vote, but lost ground in the cities, while Democrats tended to hold the urban vote, clustered into smaller geographical areas.
By its nature, the electoral system in the US favours rural, often conservative, states - a characteristic of 30 out of the 52 US states – which makes it even more challenging for Democrats to take the Senate, especially in the face of a low minority turnout.
Minority victories, but turnout still low
On the upside, the midterms saw an increase in women elected and there are now around 110 women in Congress, with Native American and Muslim women being represented for the first time. Another first was the election of the first openly gay representative to a state Senate in Indiana.
While votes were up around 31% compared to the 2014 midterms, once again, poor minority group participation contributed to the Republican victory. Turnout of black and Hispanic voters remains consistently 10%-20% below that of their white peers – with the exception of the 2008 Obama election.
If minority groups had voted in the same proportion, the Republicans would have little chance of victory. That being said, 2020 will be an interesting year, and if the Democrats really want to turn the tide they have a lot of work to do in combatting minority voter apathy. Remedies include mobilising the youth, which is easier said than done for a multitude of reasons, including voter suppression tactics aimed at deterring student turnouts in some states. They also need to broaden their campaign platforms to actively address the needs and issues of minority groups, and to actively and consistently canvas these communities in order to boost polling station turnout.
The midterm election result has potentially important internal economic implications, but limited impact on trade or foreign policy which remains in the hands of the president. The divided Congress is more likely to result in legislative gridlock and reduces the likelihood of further fiscal stimulus more broadly and an extension of tax stimulus specifically. While both the Republicans and Democrats are in favour of expanding government spending on infrastructure, they don’t agree on where this should be directed and how it should be financed. These issues will either take time to resolve or will become intractable.
With further tax relief unlikely, the future of the federal budget is a little more certain, but the degree to which Congressional divisions become acrimonious could also increase stand offs around ‘cliff’ issues such as the current suspension of the debt ceiling limit (due to expire in March 2019) and various funding bills. Associated delays and uncertainty may become a drag on economic activity.
The trade tensions induced by the Trump administration are unlikely to be affected. The pending agreement with Mexico and Canada (USMCA) does need Congressional approval, but implementation is undertaken by the administration. Any escalation or diffusion of US-China tension likewise is in the hands of the president and his administration.
Taken together, this implies that the US economy will, for now, retain its current momentum and with it a steady pace of ongoing rate hikes from the Federal Reserve. While the diminished possibility of further tax relief and further support for growth should see activity moderate from 2019, the environment in which global dollar borrowing rates are increasing will remain challenging for emerging markets.
South Africa, which runs a current account deficit of about -3.5% of GDP, is vulnerable to periods of market volatility and ‘risk off’ sentiment which could lead especially to exchange rate volatility. That said, as emerging market peers are slowing, idiosyncratic factors which may see domestic growth accelerate could support local assets.
Conclusion – what it means for your portfolios
The house and congress have been split many times over the course of US history. While this increases the prospect of political gridlock, there has typically been little, if any, bearing on the long-term prospects for the US economy and corporate profitability. As such the composition of our portfolios, and their future prospects, remain largely unchanged.