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Big money here in America will welcome it if Donald Trump is roughed up by voters in the US midterm elections, now less than two weeks away.
There’s been a huge focus on just how bad it will be it will be for the Republicans, with the consensus being that they will certainly lose control of the House of Representatives and maybe the Senate too. There has been much less attention on what this will mean for financial markets, but the prospects here are almost certainly good – good for the US of course, but on balance good for the rest of us too.
There are two main reasons for this.
First, financial markets almost always do well after the midterms. It may seem odd but share prices almost always rise in the year that follows. Why? The basic answer seems to be that historically the party in control of the White House loses seats in Congress, and that curbs the power of the president. The result is dubbed gridlock – a time when it’s impossible to pass substantial legislation – but business likes gridlock because it stops politicians doing silly things that make it harder for them to make money.
The US has had two years of a particularly mercurial President and a supportive, some would say supine, Congress. Losing control of the House destroys that relationship. Markets are jittery at the moment for all the obvious reasons, so anything that helps calm things down would be a real bonus.
Second, a weaker White House means a stronger Fed – the American central bank. Trump has viciously criticised the previous head of the Federal Reserve Board, Jerome Powell, on many occasions. His successor, Kevin Warsh, is a Trump appointment, but is sensible, thoughtful, and understands the need to rebuild the credibility of the institution that has, like all central banks, failed in its prime objective: holding inflation to 2 per cent. It is currently 3.7 per cent here in the US, with the main driver being higher fuel prices, which are profoundly unpopular and have helped send Trump’s ratings to record lows.
In the short run a tough stance against inflation means higher short-term interest rates and businesses in general do not like that, but on a longer view a respected Fed gives a stability to the economy. This matters. Back in January after one of Trump’s anti-Powell rants the chief executive of JPMorgan Chase, Jamie Dimon, observed in his characteristic downbeat way that anything that undermined Fed independence was “probably not a great idea”. He is the most important commercial banker in the US, is hugely supportive of Warsh, and his commitment to Fed independence will be really helpful if the Fed has to jack up rates sharply in the coming months.
Politics doesn’t change economic fundamentals, but the combination of a weakened President and a stronger Federal Reserve means that the US economy will be in better shape to scramble through the uncertain times ahead.
And those uncertain times? Well, for America the current financial market boom may well run on quite a bit longer. There’s a bubble associated with AI, and eventually that will pop, but don’t assume this is immediately round the corner. However, the upward grind of rising rates from the Fed and higher yields from the bond markets also goes on a while. Eventually the US, like other governments around the world, will have to cut spending and/or increase taxes – but not yet.
The impact on UK
What happens after the midterms has huge implications for the UK. We have broadly the same problems: rising inflation, high bond yields, a heavily-indebted government, and little political will to cut the deficit. We even have had an equity boom, albeit a slightly more modest one than the US: the FTSE100 is up 8 per cent this year, whereas the S&P500 is up more than 12 per cent. But America has more leeway to cope with the challenges. It has higher long-term growth, which buys it time.
All this is a sombre background for our new Government whose first real test comes with the Budget next week. But if bad news for Trump is good news for US shares, that’s also modestly good news for financial and economic confidence in the UK. The Fed will probably hold interest rates at its meeting next week, actually the same day as our Budget, but is expected to push them up in December. Rates in the UK will inevitably climb, with the Bank of England almost certainly increasing rates in November and probably again next year. Like the US, we seem to have learnt to live with more expensive money, with our economy still managing to grow a bit despite the pressures on it.
What happens in the US affects all of us. Our new Government will face a gradual ramping up the pressure to cut spending that will go on and on throughout Andy Burnham’s term of office. We’ll learn more about that next week.
Need to know
I was really surprised to see that point about the year after the midterms being historically good for share prices, as I had not appreciated it until someone here in Washington pointed it out. If this happens again, and of course it’s always possible that next year will be the outlier, then that really does buy time for investors to sort themselves out before the next serious bear market. I think it would also buy time for governments to curb their deficits. That’s because buoyant share prices are associated with growth in a two-way relationship: they reflect the fact that company earnings do better in a growth phase of the world economy, and the fact that asset prices are strong supports confidence and hence growth.
That’s why I am inclined towards the idea that governments everywhere will face a slow grind to cut deficits rather than a catastrophe akin to the measures the weaker members of the eurozone had to take during the crisis that peaked in 2012. At least I hope that is right. The way the UK fiscal deficit is sliding upwards is disturbing to put it mildly. If our economy weakens suddenly there’s nothing in the government’s tank to support it.
The other thing that has struck me here in the US is the real hatred of inflation. That has been the key failure of this Trump administration, and that will shape policies in the US for many years. If voters tell politicians they dislike this more than anything else, cutting inflation stops being a “something we really ought to do” issue for them and becomes a “we will be kicked out if we don’t do” one. That should strengthen the hand of the central bankers as they seek to fulfil their mandate of 2 per cent annual price increases, and I wonder whether this mood may lead to a rethink of that mandate.