Potentially divided US government launches tough economic debates for 2023

WASHINGTON, Nov 9 (Reuters) – Potential Republican control of at least one chamber of the U.S. Congress sets the stage for economically risky battles in 2023 over federal spending limits and the government’s response to a recession.

Tuesday’s election results remain uncertain, with President Joe Biden’s Democratic Party posting better-than-expected results and potentially able to retain control of the Senate.

The Republican Party had a better chance of winning a majority in the House of Representatives, and if that happened, it would complicate and likely temper Biden’s economic plans for his second two years in office — a time when the economy will likely suffer. yet another inflationary shock and upward adjustment in interest rates imposed by the Federal Reserve to control it.

“It will be a de facto stalemate regardless of the outcome,” said Brian Gardner, Washington-based strategist for Stifel. “The rooms will be so tightly divided.”

Deadlock can sometimes be positive for markets and the private sector, limiting the ability of either side to make disruptive changes to taxes, laws or regulations.

But it can also foul the wheels of basic governance and pose its own set of risks.

Congress, for example, will have to lift the US debt limit at some point, probably next year, but maybe not until the fall. Depending on the election outcome and the size of any Republican majority in the House, this has the potential to disrupt the economy at a time when Fed rates may still be at their peak.

Under then-President Barack Obama, the Republican Party used the debt ceiling talks to force through federal spending cuts at a time when the economy was still struggling after the deep recession of 2007-2009. a “fiscal drag” that Fed officials lamented. at the time as undermining already weak economic growth.

“A similar scenario could play out next year,” Goldman Sachs analysts wrote in an election postmortem that put the odds in favor of Republican control of the House.

U.S. stock markets closed lower on Wednesday, with major indices shedding 2% or more, as uncertainty over the election results combined with problems in the crypto industry and more layoffs across the country. tech industry.

An auction of US Treasury bonds pushed yields higher.

IS IT THE ECONOMY?

Voters cited economic problems as a priority ahead of Tuesday’s vote, with wallet pain from rising inflation and the Fed’s rate hike offsetting low unemployment, steady job creation , and household wealth and bank accounts that remain flush with budget spending during the pandemic.

In the end, voters punished the incumbent Democratic Party less than pre-election opinion polls suggested, even after Republicans used the final weeks of the campaign to point to rising food prices and gasoline.

The political and economic battle over inflation remains ongoing, however, as we approach a pivotal period in which either the pace of price increases will slow or the Fed will find it necessary to raise rates even higher than expected. currently in another blow to the economy. .

“The realignment of supply and demand may demand even more from us, creating risk for the broader economy,” Richmond Fed President Thomas Barkin said Wednesday.

In a recent Fed survey of bank loan officers, more than 57% of respondents put the likelihood of a recession in the next 12 months at 60% or more, although it should also be mild in nature. or moderate.

Unless inflation dips unexpectedly – new data will be released on Thursday – it could leave the US facing both still rising prices, high interest rates and falling output .

It would also leave fiscal policy as the main driver of any response to the recession, with decisions made more difficult by a divided regime and the beginnings of what could be a tendentious presidential election cycle.

The United States’ response to the pandemic recession in 2020, initially under Republican President Donald Trump and a Democratic Congress, then later under Biden, was seen as a textbook in some ways – with the rapid deployment of a broad net security that asked few questions other than how to avoid a second Great Depression.

But it may also have helped trigger the current cycle of inflation and pushed US public debt to record highs.

This may mean a more reluctant fiscal response to any downturn ahead.

“We continue to believe that a divided government in 2023 will underscore the shift from fiscal tailwinds to fiscal tailwinds, and likely lead to a lack of fiscal support during our forecast recession,” Nomura analysts wrote.

Reporting by Howard Schneider; Editing by Andrea Ricci and Jonathan Oatis

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