Should Markets Welcome a Republican Congress?

Should financial markets welcome or dread a Republican controlled Senate and House next Congress?

It’s a difficult question with no easy answer. But it is certainly one worth pondering because, as polls now stand, Republicans have better than even odds of picking up the net six Senate seats they need for a majority there. And House Republicans look likely to add up to a dozen additional seats, turning that chamber both more Republican and more conservative.

Free trade would certainly benefit from having Mitch McConnell as the new Senate Majority Leader (assuming he wins his own race, which is a good bet). The Kentucky Republican has voiced enthusiasm for swiftly granting the Obama Administration trade promotion authority, or fast-track. Such authority is absolutely necessary as Congressional Republicans say they will reject the Trans-Pacific Partnership and any other free trade agreement that is finalized without fast-track in place.

It is indisputable that increased trade creates both winners and losers. Yet if the desire is for more high-wage jobs – especially in an economy with a conspicuous absence of wage growth even as unemployment continues to decline – then trade is the best answer. A recent paper by Dartmouth economist Matthew Slaughter finds that workers in companies that import or export goods or services earn significantly more than those at purely domestic companies. Employees at multinationals do even better.

Majority Leader Harry Reid has opposed TPA legislation so far, but much of his resistance appears to be driven by electoral politics, as unions that oppose free trade deals will be crucial to Democrats holding the Senate. A Republican majority may be just the thing to move President Obama’s trade agenda forward.

Energy, too, may benefit from an all-Republican congress. Republicans say approval of the Keystone XL pipeline will be a top priority next year should they win the Senate. There is already significant support in Congress to approve the long-delayed project, but a strong vote for it, again led by McConnell in the Senate, would potentially give the White House the political cover it needs to finally approve the pipeline.

Financial markets would clearly cheer Keystone’s approval, as increased North American oil production continues to displace imports to the US and puts downward pressure on global crude prices, already at multi-year lows. The price of gasoline, always a major drag on consumer spending, is plummeting toward a four-year low. Such cheap energy costs will continue to be a major supply side factor in the US’s economic growth spurt. Lastly, Republicans also may embrace the idea of finally lifting the four-decade-old crude export ban.

A Republican congress would also attempt to revisit certain parts of the massive Dodd-Frank financial industry legislation. Especially helpful for the economy would be regulatory relief for small and mid-size banks, many of which are now hoarding Treasuries – partly to comply with new liquidity requirements – instead of lending.

As for reform of Fannie Mae and Freddie Mac, as well as tax reform, Republicans would push harder on those should they hold the gavels next year than would Democrats. Still, actual passage of either is unlikely before Obama leaves office (GSE reform has a small chance).

Democrats are at the moment rather unenthusiastic about making major changes to the housing lenders or to Dodd-Frank. Whereas Alabama Republican Richard Shelby, presumptive chairman of the Senate Banking Committee, considers GSE reform and alterations to Dodd-Frank top priorities, and he would likely move the ball forward.

So while Republican control of the Senate and the House would be positive for markets in a number of ways, there are also dangers in such a political arrangement.

For one thing, Senate Republicans are making clear that they will use budget bills – which need only a majority to pass – to push spending cuts to both discretionary spending and entitlements. Such a maneuver is unlikely to be received favorably by the White House and could result in a standoff or another partial government shutdown.

More worrisome still is the fact that a dozen or so Republicans who are leaving the House, either because they are retiring or have lost primaries, will be replaced by GOPers of a much more conservative stripe. Several of these candidates have already articulated hostility to House Republican leadership in general and Speaker John Boehner in particular. Their presence could cause the Speaker real headaches when it comes to passing spending bills and addressing the debt ceiling.

It is currently far from clear how Republicans, should they control both the House and Senate, will go about raising the borrowing limit, which must be addressed again by mid-2015.

And a Republican Senate majority will make it considerably more difficult for the White House to fill two vacancies at the Federal Reserve Board, a development investors should certainly frown at.

A big night for Republicans on November 4 will also energize conservative base voters, many of whom are unaware that a complete rollback of the Affordable Care Act and of Dodd-Frank, as well as an immediately balanced budget, are unrealistic and unrealizable goals. Republicans will have to carefully manage expectations among these voters. Be careful what you ask for, the old saying goes, because you just might get it.

Matthew Benjamin is Director of Political Economy at Medley Global Advisors, an independent macro-policy research firm.



Morning Consult