The Malaysian national election has come and gone. On the other side of the globe, at the time of writing, the much talked about “red wave” that was expected to sweep across the US did not happen during the midterm elections. The “red wave” is more of a “red ripple”. This time around, with investors having to grapple with so much, the midterm elections have been getting a lot less attention than expected. Historical evidence seems to point to midterm elections having a muted impact — whether it is a divided House and Senate, or some other combination or variation, the impact on short-term market performance is not significant.
For observers of former US president Donald Trump, the results have been underwhelming to say the least. Most, if not all, of the candidates endorsed by the ex-president lost to their Democrat rivals. In the run-up to the midterms, the issue of women’s rights took centre stage, but as the polls approached, this was thought to be less of a concern for voters. Instead, it was the economy, high inflation and rising interest rates that moved into focus. It was this shift that predicted the “red wave” that did not materialise. While the House of Representatives did swing to the Republican Party, it was smaller than previous midterm election swings.
The performance by President Joe Biden in the midterms is even said to be one of the best by a sitting president. The swing to the opposing political side is not large and the fact that the Democrats managed to retain their razor-thin majority in the Senate has confounded most observers. While the respective parties will conduct their post-mortems, the much-discussed observation is the dismal performance of the Trump-endorsed candidates. Whether this stems from or is related to his popularity is not known, and no one has been brave enough to predict a trend as yet.
Nevertheless, a Republican-controlled House and a Senate controlled by the Democrats is the outcome. This means the usual party line politics on annual spending, the appropriation bill and government debt ceiling issues are still likely to cause market uncertainty. Any government gridlock and inability to pay salaries of the US civil service will have negative implications, depending on the duration. Policies will need to be more reactive and compromises will need to be made in order to get things moving. And, in a year when a recession looks increasingly likely, this prognosis is not helpful at all, especially when fiscal policy action is needed to support any monetary policy by the US Federal Reserve to tackle negative growth in 2023.
How would a divided government affect policies?
The US’ industrial policy has shifted from offshoring back to onshoring. The trend of moving manufacturing capacity offshore to faraway countries has now reversed in the light of the US-China relationship. A few major policies were announced prior to the midterm elections. The Infrastructure Investment and Jobs Act (IIJA), the CHIPS Act, and the Inflation Reduction Act (IRA) look likely to drive the US’ industrial policy for the next decade at the very least. Thus, the midterms do not look likely to be a game changer.
However, there are some sector implications. For the technology sector, data privacy and anti-trust laws are likely to keep big tech platforms busy and compliance costs high. Another big tax break for corporates is unlikely and, in fact, the 15% tax on the overseas earnings of US companies looks likely to be a reality. The IRA, which aims to drive the clean energy transition, will remain but a split government would slow down the pace of the transition from traditional fuel sources. The CHIPS Act has been passed with bipartisan support and is unlikely to change even if the government is divided.
A divided government in the US is not new. And with much of industrial policy already passed prior to the midterm elections, marginal changes will not derail it in any significant way. Monetary policy will probably be used in the event of a recession to help support growth. In this scenario, the strong US dollar trend looks likely to weaken as the Fed reaches its 5% interest rate target by early 2023. With the possibility of a more dovish tone in the event of slowing growth followed by negative growth, the King dollar will likely give up its crown to support the US economy in a recession.
Emerging currencies including the ringgit will see a reversal of fortunes. Expectations for a stronger ringgit and stronger emerging currencies in 2023 seem likely, albeit more due to the US dollar’s weakness than anything that local politicians would have had you believe in the run-up to the 15th general election.
Michael Lai is executive director of wealth advisory (wealth management) at OCBC Bank (M) Bhd