A divided US Government is more often the norm than the situation we have experienced in the first two years of Donald Trump’s presidency whereby the Republicans have held the White House and both chambers of Congress (the House of Representatives and the Senate).
With the Democrats winning a majority in the House of Representatives, what seemed like an already fractious and combative policy-making process just got a whole lot harder as new initiatives get caught up in partisan politics and policy inertia. That’s a bad thing if you want legislative change, but a good thing if you want certainty and the status quo.
There are three areas of US policy we have watched closely over the past two years that will continue to impact the outlook for the US and global economy: tax, spending and trade policy. We look at each in turn and think about the implications of a divided Congress.
The Tax Cuts and Jobs Act is the landmark achievement of Mr Trump’s presidency thus far. The tax cuts that were delivered as part of that legislation had the most meaningful impact on the macro-economic outlook than anything else Mr Trump has done, delivering the late cycle boost to activity that will see the US economy achieve the highest growth of this cycle in 2018 and the Fed continue its gradual tightening pace.
We see no change to tax policy in the period ahead. Any changes put forward by the Democrat controlled House are unlikely to get through the Senate or the White House. Likewise any attempt by the President to further reduce taxes will be stymied in the House.
That’s not necessarily a bad thing. The tax cuts have contributed to a deterioration in the Federal Budget balance at a time when the economy is at its cyclical peak. The strongest GDP growth in a decade has coincided with a deterioration in the Federal deficit from -2.4% of GDP in late 2015 to -3.8% in the year to September 2018.
Indeed, we are already concerned that as the economy slows as we head into 2020, the US will have limited room to move on fiscal policy.
Which brings us to spending. The US is currently operating under a two-year budget deal that expires in September 2019. Under current law, inflation adjusted discretionary spending would need to decline in the 2020 fiscal year, generating a drag on growth as we saw over the period 2011 to 2014. Such an outcome wouldn’t help either party, so a compromise deal that has a more neutral impact on the economy appears likely.
There are risks around this in both directions. Mr Trump’s penchant for stimulus will be to the fore as the economy slows into 2020. Infrastructure appears the most likely candidate if stimulus is to get bi-partisan support. But equally likely is the possibility of a long budget standoff as debt ceilings are close to breaching and a more negative impact on the economy ensues.
There has been considerable progress on the trade policy front. While the headlines have been firmly focused on the escalation of tensions between the US and China, over the last few months the US has renegotiated its trade agreement with South Korea and is negotiating with Europe and Japan.
The new US/Canada/Mexico agreement will likely be signed by the President in the next few weeks, though its will still face votes in the House and the Senate next year. A Democrat House will make the signing of the new trade agreement a bit more convoluted, though the President’s Trade Promotion Authority will ensure it is eventually signed.
That leaves the trade dispute with China as the most significant trade issue. Our view has been that the President will want to being this to a conclusion sooner rather than later. He wants to win something before the popular backlash of rising prices means he is on the back foot. Indeed, we saw signs of this immediately prior to the elections with suggestions of a meeting between the US and Chinese Presidents at the upcoming G20 meeting in Argentina.
In short, we see no significant policy changes of the magnitude we saw post the 2016 election, but there are still significant challenges to navigate that have the potential to be disruptive for markets.
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