Fed meeting in focus

By David Morrison  |  07/11/2018 15:53

The results are in for the US mid-terms with Republicans holding the Senate but losing the House. This state of gridlock has led to a dollar sell-off but strong gains for stock indices. Attention now turns to Thursday’s Fed meeting

The Republicans managed to extend their majority in the Senate but lost control of the House of Representatives. The result was broadly in line with polls which was perhaps the biggest surprise of yesterday’s mid-terms. While still awaiting the official tally, it looks as if the Democrats have picked up around 33 seats in the House, above the 23 needed for a simple majority. However, the Republicans have increased their majority in the Senate by at least three seats.

No ’Blue Wave’

The ‘blue wave’ that Democrats were hoping for never materialised, suggesting that a significant number of voters are happy with Trump’s presidency, even if they deplore his non-stop tweeting and boorishness. In fact, President Trump’s pre-election whistle-stop tour of key areas boosted turnout and the Republican vote. On top of this, many of the Republicans who lost their seats could be described as ‘moderates’ who often took issue publicly with the president. Overall then, Mr Trump has plenty to be happy about today.

Gridlock - good for markets?

Congress is once again gridlocked which means legislation will be more difficult to pass. This is generally seen as good for financial markets as it means less political interference. Certainly, equities liked the result although we also saw the dollar weaken as the fresh political situation materialised. The Senate majority means Trump has increased his control of cabinet and federal judiciary appointments. But the Democrat majority in the House means no more tax cuts – corporate or otherwise. There should be discussions and shared interest on infrastructure spending. But given the rancorous nature of US politics, agreement between Republicans and Democrats will prove difficult to obtain. There has been some speculation that Trump may have to dial back on his ongoing trade dispute with China. But this may be misplaced. The Trump administration’s aim is to bring an end to China’s alleged intellectual property theft while boosting cybersecurity. With these issues unresolved, there’s every chance that Trump follows through on his threat of higher tariffs on Chinese imports. Along with halting further tax cuts, gridlock is also likely to bring an end to plans to deregulate banking, financial services, the energy sector, industrials and even small businesses.
 
Market reaction

Looking back at SocGen’s market reaction cheat-sheet, it looks like they had it about right with a Republican Senate and Democrat House leading to a spike in equity market volatility before investors once again fret about tighter monetary policy from the US Federal Reserve. They anticipated a limited reaction from the dollar, although they now expect it to weaken going into next year. But of course, what happens to the dollar has much to do with outside forces, particularly the European Union’s showdown with the Italian coalition government over the latter’s deficit-busting spending plans and the ongoing Brexit negotiations.

Federal Reserve meeting

But domestically it’s all about the Fed and the US central bank’s determination to tighten monetary policy, in the face of direct criticism from the president. Thursday sees the Fed’s latest two-day monetary policy meeting end. On the face of it, this shouldn’t be a particularly significant meeting. For a start, it isn’t a big quarterly one in which the Federal Open Market Committee (FOMC) updates its Summary of Economic Projections. Nor will Fed Chairman Jerome Powell be holding a press conference after the rate decision is announced. Typically, it’s unusual to get a move in rates at a November meeting. However, this meeting will be notable as it will be the last one without a press conference from the Fed Chair. In addition, there has been some speculation that the Fed statement may include some further clues as to the pacing of future rate hikes and balance sheet reduction. But it would be very surprising to read that the Fed is thinking of keeping rates unchanged in December. For a start this would suggest that the central bank is bowing to political pressure. But just as importantly, the Fed would effectively be saying that the US economy can’t handle higher rates. This would be despite the Unemployment Rate holding at its lowest level in 49 years, and inflation (as measured by Core PCE) bang on the Fed’s 2% target with wage pressures rising. Any indication of the Fed skipping a rate hike next month could, ironically, lead to another pull-back in equity markets.

Trump on top

One thing is for sure, with the Democrats running the House, President Trump now has two scapegoats to blame for any future economic slowdown or stock market meltdown. Bear in mind how quick the president has been to blame Jerome Powell for causing the October equity sell-off due to the Fed Chairman’s insistence on raising rates. Now Mr Trump also has the Democratic majority in the House of Representatives who he can blame for blocking his plans for further tax reductions and the promised cuts of regulations holding back US businesses. Politically it’s possible to argue that while the mid-terms were disappointing for the GOP, they represented a great result for the president.
 
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