The results of Tuesday’s election are still murky, but strategists are betting there will at least be a thin Republican majority in the House of Representatives to help block any big Democratic spending programs. That would be viewed as a positive by markets, which generally see gridlock in Washington as a good thing and clearly prefer divided government to the current Democrat-controlled Congress. Stocks are usually higher in the final quarter of midterm election years, and have also always gained in the 12 months from Nov. 1 of the midterm year to the following November. Results of many races were too close to call by NBC News Wednesday and the balance of power is still unclear. Therefore, there is no declaration yet of victory for either party in the House or the Senate. “We think Republicans will have the [House] majority, but it’s going to be a very narrow majority,” said Ed Mills, Washington policy analyst at Raymond James. Mills said he expects the Democrats could keep the Senate, but the outcome may not be clear until next month after the runoff election in Georgia. “From a market perspective, we had said those were both positive market outcomes, and we had argued that a close Senate, even a Democratic Senate, keeps the fight between the House and Senate rather than Congress and [President Joe] Biden,” Mills said. “The more you can keep the fight between the House and Senate that slightly reduces some of the brinksmanship out there.” Debt ceiling battle That reduction of tension could help when it comes to the debt ceiling. The first big showdown for the new Congress and White House is expected to come with the debt ceiling, which could be reached sometime early next year. The borrowing limit was last raised by $2.5 trillion in December 2021. Expanding the debt limit does not allow new spending but covers government expenditures that were already approved. “Small majorities are messy and the process will produce headlines that are very dysfunctional at times. … Does it matter if the process is going to be messier?” said Mills. “What matters is that for the debt limit, Republicans have fewer members to hold hostage. So, is the threat somewhat decreased?” Strategists say it is possible that some Republican House members may be motivated to cooperate with Democrats to resolve the debt ceiling in the lame-duck session, before the next Congress is sworn in to office in January. Republicans have said they would only agree to expand it in exchange for spending cuts, and strategists have said that could result in a contentious battle. “I think there’s an argument to be made for the incoming Republican leadership to say let’s take this off the table,” said Tom Block, Fundstrat Washington policy analyst. Some strategists had expected a better showing by Republicans, with them gaining a wider majority in the House, in addition to winning control of the Senate. If Republicans hold a majority in the House, as expected, tax increases are unlikely as is much in the way of new spending. “I think spending will slow down. As long as the Republicans control one body, and they could end up controlling two, every bill has to pass the House and Senate and Republicans will insist on certain reductions,” said Block. Positive for energy Block said Fundstrat’s analysts see the potential for positive impacts on the energy and defense sectors. Republicans are expected to favor spending more on defense, and they would support legislation to speed up permits for oil and gas firms. That could help pipelines and drillers. “China is still one of the few bipartisan issues. Also antitrust privacy legislation. That’s a big bipartisan issue,” said Mills. Goldman Sachs policy analysts said in a note that without the Senate it would be even harder for Republicans to make significant changes that will affect Democratic policies that were already put in place. “Sector-focused policy changes would be even more limited under a divided Congress than under Republican control,” the analysts wrote. “Changes to energy or health policy — such as rolling back changes made in this year’s Inflation Reduction Act (IRA) — did not appear very likely under a Republican Congress and appear even less likely if control of Congress is split.” Fed is the focus Strategists say the market’s main focus continues to be the Federal Reserve’s policy tightening and, with the election out of the way, investors await new inflation data Thursday, since it could drive interest rate policy. “A potential positive outcome could be that with fiscal stimulus less likely, the Fed would feel less compelled to counteract fiscal policy with restrictive monetary policy,” wrote Ned Davis strategists in a note. “Ultimately, wages, inflation expectations, supply chains and global commodity markets will determine whether the Fed can halt the most aggressive tightening cycle in four decades, but gridlock would remove one inflationary risk.” The strategists note that the downside could be if there’s a recession next year. “Congress may be less likely to support the economy, deepening the risk to markets and earnings,” the Ned Davis strategists noted. “One trend that the election is unlikely to change is that politicians are pushing more responsibility for the economy onto the Fed, regardless of whether it is the best institution to deal with the problems at hand.” Mills said the central bank itself could become a bigger target for Congress next year, as it continues to raise interest rates. “I do think the knives are going to start coming out for the Fed, especially if we see a tick up in unemployment, and that’s going to come from Democrats,” Mills said. Mills said Democrats have already started to question interest rate policy, and there could be more rhetoric to come. “The Fed is independent because the president and Congress has given them that independence,” Mills said. “If there is a policy mistake by the Federal Reserve that questions the current setup, that is the biggest political threat to the Federal Reserve. That’s why you have to listen to some of the criticism that comes from Congress.”
