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Neck and neck U.S. midterm races threaten Wall Street's split-government hopes

Published 11/13/2022, 03:41 PM
Updated 11/14/2022, 05:16 PM
© Reuters. FILE PHOTO: Signage is seen at the New York Stock Exchange (NYSE) in Manhattan, New York City, U.S., November 11, 2022. REUTERS/Andrew Kelly/File Photo

(This Nov. 13 story has been refiled to say in headline 'Neck and neck U.S. midterm races' rather than 'Democrats' big midterm gains'.)

By Rodrigo Campos and Ira Iosebashvili

(Reuters) - A stronger-than-expected showing by Democrats in the U.S. midterm elections may force investors to rethink the split government scenario many had expected.

Democrats held onto control of the U.S. Senate, extinguishing hopes of the "red wave" that Republicans had expected leading into the midterm elections. Republicans remain close to seizing control of the House of Representatives as officials continued counting ballots, with results expected to become apparent over the next several days.

Following last week's midterm vote, investors had largely expected a split government, with Republicans gaining control of the House, Senate or both while Democrat Joe Biden remained in the White House. While a Democratic sweep is still seen as unlikely at this point, perceptions that such a result is within the realm of possibility could ignite worries over spending and legislation that many investors had put to rest.

Quincy Krosby, chief global strategist at LPL Financial (NASDAQ:LPLA), believes more power in Congress for Democrats may pit fiscal and monetary policy against each other, potentially delaying the Federal Reserve's efforts to fight inflation.

"If the goal is to curtail demand, we could now have policies that underpin demand," she said.

Returns are still flowing in for several House races, including many in liberal-leaning California. As of early Sunday, Republicans had won 211 seats and the Democrats 205, with 218 needed for a majority.

Spending is a worry for some investors because they believe it could buoy inflation and potentially force the Fed to ramp up their market-punishing monetary tightening policies. Softer-than-expected inflation data last week spurred hopes the Fed could temper its rate hikes, sparking a sharp rally in stocks and bonds.

Wall Street tends to view split government favorably, in part because some investors believe it makes major policy changes more difficult to achieve.

A split government could stymie Democrats from pushing through several large fiscal packages, including $369 billion in spending on climate and energy policies, and enacting a windfall tax on oil and gas companies, analysts at UBS Global Wealth Management wrote earlier this month.

Still, "Federal Reserve policy, rather than fiscal policy, will remain the main driver of markets in our view," they said.

In the same vein, analysts at Morgan Stanley (NYSE:MS) wrote before last week’s election that Democrats expanding their majorities in Congress could lead markets to "assign a higher probability to further fiscal expansion, with Congress and the Fed

effectively pulling in opposite directions on inflation."

"The short-term implications for markets could be higher Treasury yields and stronger dollar, reflecting the potential for higher peak federal funds rate."

© Reuters. FILE PHOTO: Signage is seen at the New York Stock Exchange (NYSE) in Manhattan, New York City, U.S., November 11, 2022. REUTERS/Andrew Kelly/File Photo

Historically, stocks have done better under a split government when a Democrat is in the White House: average annual S&P 500 returns have been 14% in a split Congress under a Democratic president, according to data since 1932 analyzed by RBC Capital Markets. That compares with 10% when Democrats controlled the presidency and Congress.

Of course, either configuration is far better than the market's performance this year. Even after rebounding in the past week, the S&P 500 is still down 16.2% for the year.

Latest comments

Yeah. It's really tough to get people to belive that Trumpublican horse ____ anymore.
Democracy is dead.
Not where I live.
I wouldn't be surprised if Joe Biden got 100% of the votes in 2024.
So, they are losing the House just to make it all believable?
My homies😁
Republican Lauren Bobert was loosing, so they spent days counting more votes and now she's winning. FAKE!
we need a more transparent system like they have in Florida. and no more counting ballots for days it's so sus.
In what state do you find a lack of transparency?
dems will get enough to win. we only have to wait a little longer and they will have the house too. fake news and fake elections.
Yes Dems know last minute vudoo, a special gift from africa😁
the longer this go's on the more votes come out of the woodwork free and fair not anymore.
Dem’s gonna win and economy will be good because they print money for all and free. Probably you will receive a stimulus check for free, they will buy you somehow and thats good✌️
Don't fight the Fed, unless you are Joe and Co.
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