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US elections: the Fed's policy will play out (in part) in Congress

Days away from D-day, all eyes are fixed on the candidates' proposals1 . Hillary Clinton has clearly increased her lead in the polls over the past few weeks. Nonetheless, in fiscal matters, it's Congress that makes the decisions2 . Since the two chambers are on a level playing field, the majorities reached in the House of Representatives (HoR) and the Senate will affect possible compromises in the same way. The Fed, which is calling for a rebalancing of the policy mix, will not be impervious to the new balance of power created by these elections.

There are three possible outcomes:

1/ Republicans retain their majority in both the House and Senate;

2/ Republicans retain their majority in the HoR, but Democrats regain control of the Senate3 ;

3/ Democrats gain the majority in both chambers.

Let’s now assume that Hillary Clinton wins the presidency.

In the first scenario, the US would most likely be paralysed on the fiscal front. Unless there were a dramatic economic downturn, with a recession risk at stake, Congress and the White House would not reach an agreement. Such a situation would probably be viewed rather poorly by the markets, and the Fed would remain conservative, with a status quo likely in 2017.

The second scenario – which is, as of now, the most likely – would clear a path to bipartisan compromise, specifically on infrastructure spending. However, in light of very divergent positions on social spending and on taxation, it would take time for Democrats and Republicans in Congress to reach an agreement.

Only in the third scenario, which is highly unlikely at this stage, could we expect a broad fiscal expansion plan, Democrat-style, to be rapidly approved.

Note that in this latter case, the Fed would probably raise its key interest rates throughout 2017 (a 100 bp hike would be realistic). A recent article by Stanley Fischer4 gives this hypothesis some shape. He offers up the Fed model's simulations (FRB/US) by which a spending increase of around 1% of GDP would contribute to raise the neutral interest rate5 by 50 bp. In the third scenario, the markets would quickly have to revise their key interest rate assumptions upward at the 12 month horizon. In the second scenario, we would have to closely monitor the progress of negotiations between Democrats and Republicans.




1 For an analysis of scenarios and their impact on the markets, see our article, "TRUMP vs. CLINTON: investment challenges and strategies" released on 26 October.

2 Democrats have about a 60% chance of dominating the Senate, according to recent polls.

3 In theory, we should also consider the reverse, where Democrats gain the majority in the House but not the Senate. Yet beyond the fact that this scenario is highly unlikely, the consequences would not be fundamentally different.

4 “Why Are Interest Rates So Low? Causes and Implications”, speech, Stanley Fischer, 17 October 2016. 5 Technically, it is the constant of the Taylor Rule that would be adjusted upward, supposing higher potential growth.







BOROWSKI Didier , Head of Global Views
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US elections: the Fed's policy will play out (in part) in Congress
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