After the vote

Budget deficit back in focus

In terms of immediate investment implications, a narrow GOP majority in the House and Senate does limit—and probably eliminates—the chance of any further fiscal stimulus via congressionally authorized federal transfer payments. This is constructive for bond markets, as any additional fiscal stimulus in this inflationary environment would be a big negative—the recent turmoil in UK proving a good example.

In our view, the magnitude of the cumulative US budget deficit will be an important issue in the next few years, now that yields have risen and the budget deficit is more expensive to finance. While this has not been a very potent issue in the last 10–15 years, it’s highly likely to become a hot button issue again—and with US defense spending destined to rise, it means there will be more debate over whether to reduce social service spending.

More noise around the debt ceiling

We also anticipate political brinkmanship around the debt ceiling in the late summer of 2023 if the "lame-duck" session of Congress does not address the issue next month. If the Democrats retain control of the Senate, they might be motivated to raise the limit in December and thereby avoid a fight with a House Republican majority, many of whom have already indicated a demand for cuts to social spending in return for a vote to raise the limit. But if that fails to pass, we expect greater volatility around this debate sometime in the third quarter of 2023.

Congress has always increased the limit in the past, but the manner in which they do it and how close they cut it will have implications for markets. Unfortunately, it has often come down to the wire. A protracted political standoff in 2011 caused the S&P to downgrade US credit rating for the first time. That sent borrowing costs and credit default swaps meaningfully higher for a brief period as the deadline approached. In 2013, we also saw short-term Treasury yields rise by as much as 50 basis points in a matter of days as the so-called "X date" approached. Corporate commercial paper yields rose, and some Treasury securities were rejected by lenders as eligible collateral. With fixed income yields already so volatile, any disruption to the short-term credit markets has the potential to spread to other asset classes. Relying on the Federal Reserve, which is tightening monetary conditions, to provide the necessary liquidity to limit the market turmoil would only add to the uncertainty.

In the end, we do expect Congress to raise the debt ceiling because the consequences of not doing so—especially in an already fragile market environment—are significant. But we cannot rule out increased volatility as the deadline approaches.

Biden to pivot to foreign policy

With limited scope for material domestic policy action, we expect Biden to pivot to foreign policy and geopolitics over the next two years.

The implementation of a more adversarial posture toward China is among the few policies in Washington where both parties agree.

Assistance for Ukraine still has majority support within each party, but there is dissension within the ranks. Some GOP members on the right do not view Ukraine as strategically important to the US, while the progressive wing of the Democratic Party views aid to Ukraine as competitive with US domestic social spending. A narrow majority makes it more difficult to enact the legislation to provide aid because neither political party is anxious to strike a bipartisan deal that will alienate the respective hard left and hard right wings of their parties. We still expect the broader consensus to prevail, but the odds of a delay in providing support will increase next year.

What should investors do?

Certain investment themes stand to benefit from the current policy environment. While any new major climate legislation would be unlikely under a divided government, funds already allocated from the recent Inflation Reduction Act and last year’s bipartisan infrastructure plan will continue to provide policy support for green investments. And even amid gridlock, the policy environment should also remain supportive overall when it comes to both conventional defense and cyber spending, as well as securing energy, food, and semiconductor supplies.

But make no mistake, the ultimate driver of both equity and bond markets in the near-to-medium term, as we have been saying for the past year, remains the macroeconomic outlook and specifically the Federal Reserve’s monetary policy. Investors should continue to focus on the fundamentals and not let their political biases affect their investment allocation decisions.

Meanwhile, as dawn approached, many of the contests for the US Senate’s most competitive seats remained exceptionally close. Lieutenant Governor John Fetterman was declared the winner in the race to represent Pennsylvania in the US Senate, defeating celebrity physician Mehmet Oz. Incumbent GOP Senator Ron Johnson fended off a challenge from Democratic Lieutenant Governor Mandela Barnes in Wisconsin. Another runoff election for the US Senate will take place in Georgia on 6 December, according to the Georgia Secretary of State’s office, but Fetterman’s win in Pennsylvania provides Democrats with a margin of error as we await the result of the final two pivotal races for the Senate in Arizona and Nevada.

There were 36 gubernatorial seats on the ballot in 2022. The contest in Arizona, pitting Democrat Katie Hobbs against Republican Kari Lake, received the most media attention due in part to the latter’s persistent accusations of election fraud in the 2020 presidential contest. Hobbs appears poised to win that contest but the final vote count may not be available until later this week.

According to the US Elections Project at the University of Florida, 45.9 million voters across the US cast their ballots prior to Election Day. More than half—55%—chose to return their votes by mail. The remaining 45% voted early, but in person. Some state statutes prohibit the early tabulation of absentee and mailed ballots. In other instances, the procedures under which votes are counted are laborious, which could delay the certification of election results in the closest contests for a few days.

Governor Ron DeSantis took a victory lap after handily defeating his Democratic challenger, Charlie Crist. His win for a second term as Florida's governor positions him for a presidential bid in 2024. Meanwhile, many candidates endorsed by Donald Trump failed to meet expectations, which has led to a round of recriminations within the GOP regarding the former president’s active participation in this year’s midterm election campaign.