Michael Zezas: The Midterm Elections’ Market Impact

It’s almost two full days after the midterm elections in the U.S. and while we still don’t know the outcome, markets may know enough to forecast its impact.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Michael Jesus, Head of Global Thematic and Public Policy Research for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between public policy and financial markets. It's Thursday, November 10th, at 3 p.m. in New York.

It's nearly two full days after polls closed across America, and we still don't know which party will control Congress. But for investors, we very likely know all we need to know at this point. Let me explain.

It may take several days, maybe weeks to determine which party will control the Senate. But knowing which party controls the Senate won't matter much if Republicans gain a majority in the House of Representatives, as they appear likely to do as of this recording. That's because Republicans controlling at least one chamber of Congress is enough to yield a divided government, meaning that the party in control of the White House is not also in control of Congress and so can't unilaterally choose its legislative path.

For bond markets, this is a mostly friendly outcome. It takes off the table the scenario that could have led to fiscal policy from Congress that would cut against the Fed's inflation goals. That scenario would have been one where Democrats keep control of the House and expand their Senate majority. That outcome might have suggested inflation was less a political and electoral concern than previously thought, and through a broader Senate majority, given Democrats more room to legislate. If markets perceived that combination of a willingness and ability to legislate as increasing the probability of enacting spending measures, like a child tax credit, that would support aggregate demand in the US economy, then investors would also have to price in the possibility of a higher than expected peak Fed funds rate, pushing Treasury yields higher. Of course, this appears not to be what happened.

So, the bottom line, the election outcome is important and still up in the air, but markets may know enough to move on.

Thanks for listening. If you enjoy the show, please share Thoughts on the Market with a friend or colleague, or leave us a review on Apple Podcasts. It helps more people find the show.