AXA IM: Biden on track for slim control over Senate

AXA IM: Biden on track for slim control over Senate

Verenigde Staten Politiek
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David Page, Head of Macro Research at AXA Investment Managers, comments on the US Senate run-off elections:

  1. Georgia’s run-off elections for Senate have delivered one declared Democrat seat, and one likely.
  2. A recent swing in polls in recent days for Democrats has coincided with President Trump’s latest interventions.
  3. A 50-50 split Senate would hand control to the Democrats by virtue of the Vice President’s casting vote – a rare occurrence in US history.
  4. Democrats will control the Senate agenda and have a majority on committees. They will now be able to overcome the Republican filibuster, but could pass key legislation through reconciliation.
  5. Short and long-term fiscal packages will be the key development. The latter suggests marked upside growth risks to the medium-term outlook.
  6. Market reaction should be mixed. Government bond yields and the dollar are likely to rise, but on balance we expect equities to underperform.
  7. The current composition of the Senate may also boost Vice President Kamala Harris’ chances of becoming President in future elections.

Georgia held the second round of its Senate elections for two seats yesterday. The Associated Press has declared one of those results for Democrat Raphael Warnock, who beat Republican incumbent Kelly Loeffler 50.6% to 49.4% with 98% counted. The other race, between Republican incumbent David Perdue and Democrat Jon Ossoff is closer at 49.8% and 50.2% with 98% counted, but looks likely to deliver another Democrat victory. This would take the Senate split to 48 Democrats, 2 independents, who caucus with the Democrats, and 50 Republicans. A 50-50 split in the Senate can be decided with a casting vote from Democrat Vice President Kamala Harris, handing Democrats effective control of the Senate. Interestingly, while polling had been tight in these races for months, both Democrat candidates saw a last minute boost in numbers, which coincided with last minute interventions by President Trump, not least the publication of a taped phone call between the President and Georgia’s Secretary of State.   

Democrat control of the Senate is a material and unexpected development, however, it will not give Biden a carte blanche to implement his manifesto. Firstly, this control will allow Democrats to control the Senate agenda, meaning they will choose which issues are to be voted on (and which can be avoided). Secondly, it will give Democrats a majority on committees. However, Democrat control is wafer thin. Any complications, from Covid absences to premature resignations or deaths would remove this majority. Moreover, Democrats (and independents) would have to be united to guarantee a majority – something that cannot be guaranteed on a variety of issues. More importantly, Democrats are far short of the super majority (60) required to prevent Republican filibuster, which can effectively block the passage of legislation. That said, Democrats can still use the process of “reconciliation” to pass legislation with a simple majority – although the conditions in which reconciliation can be applied have changed over the last decade and are restrictive.

In practice, this will allow the Democrats greater control over legislation and the possibility for President-elect Biden to enact a major piece of legislation. This is likely to boil down to two specific issues for markets – short-term and long-term fiscal stimulus. In the short-term, despite having passed a $0.9trn stimulus bill in the final throes of last year, this was far short of Democrat ambition. The Democrats may hope to pass a top-up stimulus package over the coming months, which will be more likely if the new variant of COVID spreads across the US as Anthony Fauci, Director of National Institute of Allergy and Infectious Diseases has suggested. In the medium-term, Biden campaigned on a “Build Back Better” agenda, a plan to raise tax revenue from corporates and high net wealth individuals and to increase infrastructure and other government spending. Biden’s manifesto pledges were large and a more moderate final bill is likely. But these Senate run-off outcomes raise the prospect of a material longer-term spending bill being passed, although probably not until 2022.

The raised likelihood of these two fiscal developments is likely to guide the economic outlook and market reaction. The prospect of additional short-term stimulus should address some of the downside risks that a further spread of the virus and delayed start to the inoculation programme threaten. For now we stick with our above-consensus outlook for US GDP growth this year of 4.6%. However, the prospect of a future major spending programme provides a material upside risk to our forecast for 3.7% in 2022 and beyond. Even assuming Biden managed to enact only one-third of his agenda, our estimates suggest growth could be boosted by as much as 2ppt in 2022 and 2023, representing a material difference. A precise, upgrade to our forecast will necessarily wait until a clearer understanding of the new administrations plans emerge. But this election result suggests upside growth risks to the medium-term outlook.

Shorter-term market reaction is more uncertain. The prospect of more fiscal stimulus and faster growth should lead to a quicker rebound in inflation (and should further support inflation expectations). It also suggests that monetary policy will have to remain supportive for a shorter period. Both developments suggest a rise in market interest rates. 2-year US Treasury yields have risen by 2bps to 0.135%, but 10-year yields rose by 10bps to 1.02% - breaching 1% for the fist time since last March. Broader market reaction is less certain. The prospect of more fiscal policy and less monetary stimulus should support the US dollar. The dollar has fallen by 5% since the November election against a basket of currencies and we would expect some of that loss to be unwound. However, the immediate market reaction has seen further dollar weakness. Finally, the equity market outlook is complicated. A firmer growth outlook should support equities, but the possibility of a rise in the corporate tax rate and less monetary support lead us to expect a net negative reaction. Since the election, the S&P 500 index has risen by over 10% - some of these gains may be unwound. However, the precise balance of the equity index may govern the overall reaction with large and tech companies maybe facing the most to lose from changes in corporate tax plans, while smaller companies may benefit more from a broader recovery in economic activity. Early futures trading, which saw losses in the S&P 500 index, but gains in the broader Russell 5000 index may reflect such considerations.

Looking further ahead, there are additional political implications from these Senate developments. First, Democrats will go into the 2022 Mid Terms in a stronger position. The balance of those Mid Terms already favours the Democrats with 22 of the 34 seats up for grabs in 2022 Republican, although Mid Terms are rarely advantageous to the incumbent party. Second, the Senate make-up will place Vice President Kamala Harris in the spotlight. An even Senate split has been rare, only for short periods (up to 6 months) since the 1880s. While this remains the case, Harris is likely to garner more attention than previous Vice Presidents. With many commentators suggesting that President Biden would only stand for one term – something he has denied – the selection of his Vice President was deemed all the more important, with 12 Vice Presidents having run for President from this position. Increased visibility can be a double-edged sword, but will raise Harris’ recognition amongst the US public over the coming years, which could have influence over the next Presidential Election in 2024.