HIGHLIGHTS OF THE WEEK
- Between the midterm elections and a Fed rate decision there was plenty of news this week. But after the dust settled there was very little new information.
- In the midterm elections, Democrats gained a majority in the House of Representatives, and Republicans tightened their grip on the Senate. A divided Congress through 2020 will temper parts of Trump’s agenda, and could make some upcoming fiscal tests more challenging.
- As expected, the Federal Reserve left rates unchanged, with a largely unchanged statement. Recent economic data suggest the next hike is coming in December.
Plenty of News, But Not Much New
Between the midterm elections and a Fed rate decision there was plenty of news this week. But after the dust settled there was very little new information. As was widely expected, the Democrats gained a majority in the House of Representatives, and Republicans tightened their grip on the Senate. A divided Congress will temper Trump’s agenda, but much depends on the Democrats’ strategy for working with the GOP. Even less surprising was the Federal Reserve’s decision to hold the funds rate steady, after hiking in September. Equity markets seemed pleased with these largely as expected results.
Congress is now gridlocked through 2020, which raises risks on a variety of fronts. A few tests loom on the near-term horizon. Currently 25% of discretionary spending for the 2019 fiscal year is under a temporary funding agreement until December 7th. The current Congress will likely kick the can into early 2019, which sets up a potential funding battle and the risk of a partial government shutdown in the New Year. Government shutdowns are a risk with a divided government, but typically these do not have a meaningful impact on economic activity (as they have not proved long lasting).
The second fiscal test is the debt ceiling, which is set to be re-instated in March 2019. It must be raised or suspended again to prevent a debt crisis or huge fiscal contraction. We expect Congress will come to an agreement to avert a crisis, but there could be some fireworks in the process. Finally, Congress must enact legislation to avoid automatic spending cuts of $100 billion in FY2020. Our base case is that this is avoided, but if not, it could trim 0.5 percentage points from GDP growth in that year. In the wake of tax cuts and spending increases the federal deficit has grown, and is expected to swell further (Chart 1). This could become a political issue that makes a budget compromise more difficult.
As President, Trump has the authority to push ahead with his trade agenda. He may even get some support from the Democratic House for a harder stance on China. As such, the increase in Chinese import tariffs to 25% from 10% on $200bn of goods on January 1st is more likely than not, presenting a downside risk to our forecast.
Finally, there was little new from the Fed. The statement’s characterization of the economy was broadly unchanged. The slight updates that were made merely reflect the latest data, and are not major new developments. Most importantly, the Fed said it “expects that further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity…” and that “risks to the economic outlook appear roughly balanced”. The recent economic data certainly point to a rate hike at the December meeting.
Most recently, October’s Producer Price Index showed that inflationary pressures are alive well further up the supply chain. And while consumer price inflation hasn’t heated up in recent months, price hikes are likely coming in many sectors as margins are increasingly squeezed.
Leslie Preston, Senior Economist | 416-983-7053
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