The midterm elections may give the US economy a short-term boost, but bigger challenges remain

There usually is a return of confidence to equity markets after the midterms, if only because the elections frequently result in gridlock. Markets like it when politicians cannot do very much

A president at loggerheads with the Fed is not good. Puffing up the economy at the top of the cycle is not good (AFP/Getty)

The outcome of the US midterm elections is good news for the US and world economies for at least half a dozen reasons. Let’s go through them, and then think about the rest of the year and beyond.

One, the Republicans losing control of the House means that it will be impossible, or at least very difficult, for the president to get controversial legislation through Congress.

That scuppers another round of tax cuts. This is welcome because it is never a great idea to have a looser fiscal policy when the economy is near the top of an economic cycle. The present round of cuts has boosted the fiscal deficit to around 4 per cent of GDP and a further set would have been really worrying.

Two, had there been further tax cuts the pressure on the Federal Reserve to increase rates would have been even greater than it is already. While the US economy does need higher interest rates (and will get them), you don’t want to put more pressure on monetary policy than necessary.

Three, in any case there will be continuing tension between the president and the Fed. Property developers like cheap money to get their projects financed and a bit of inflation later will increase the capital value of their buildings. The Fed has to lean against inflation, currently 2.3 per cent and expected to firm in the coming months. The markets do not expect anything at the Fed meeting this week, but do expect the next increase in rates in December.

Four, there is already a danger that dollar strength is unsettling the world economy for a number of reasons, including the impact on the emerging countries. Dollar strength is now more likely to be capped.

Five, if the president cannot get much domestic stuff through Congress he will focus on international affairs. He will want some “wins”. A trade deal with China could be one; some kind of accord with Europe another. An outward-looking America, even if adopting a nationalistic stance, is better news for the world economy than an inward-looking one.

Six, importantly, the president was not humiliated. Increasing the Republican majority in the Senate enables him to present the results as a typical midterm politics-as-usual outcome. Anything else – either the Republicans retaining the House or the Democrats gaining both the House and the Senate – would have been destabilising.

The checks and balances are working. The economy is strong. Wage growth is strong. Unemployment is down to 3.7 per cent, the lowest for 49 years. Shares are up around 25 per cent since Donald Trump was elected. You can argue with some justification that this economic success is not down to the president; that it is a result of wider strengths of the US system. But this is the way things are supposed to work, and that is just fine.

What’s next?

Well, there will probably be a return of confidence to equity markets. There usually is after the midterms, if only because the elections frequently result in gridlock. Markets like it when politicians cannot do very much. So no further tax cuts or deregulation, but also no rescinding of the existing pro-business legislation. How long confidence returns for is of course another matter, but in the short term this is positive.

Next, expect more infrastructural spending in the US, for this is one area where the president and the new House may agree. The US needs more infrastructure spending, though be aware that it takes time to get moving. Projects are not “shovel-ready”. So any economic boost is two or more years away.

Otherwise, expect the discordant tone of Washington to continue, and expect there to be specific ructions over, for example, raising the debt ceiling. This is one tried and tested way Congress likes to curb the administration, and we could easily see another of those habitual shutdowns of government next year. We should not fret about this, for it is the way Washington operates.

But I am worried about one thing, not so much a result of these elections, but rather how the country will manage the cyclical economic slowdown as and when it comes. A president at loggerheads with the Fed is not good. Puffing up the economy at the top of the cycle is not good. The global impact of ultra-easy money has not been good – a useful policy carried on for far too long.

All in all, the outcome of the midterms is encouraging, but the challenges loom.