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The policy impact of the “split Congress” in the United States

  The mid-term elections in the United States have been going on for two weeks, and the results are largely clear. The Republican Party will seize control of the House of Representatives, while the Democratic Party will continue to control the Senate with a slight advantage. The United States will enter the stage of “split Congress” in the next two years.
  As of November 18, the Republicans won control of the House of Representatives by 218:212 votes. The Democrats have locked 50 seats in the Senate. With the vice president’s 1 vote, they will actually continue to control the Senate.
  Since the U.S. House of Representatives has absolute say in fiscal and taxation, “split Congress” will hinder the Biden administration’s financial subsidies and stimulus in the next two years, and the debt ceiling issue will also interfere, which may increase the U.S. economy to a certain extent. The risk of a recession, which adds more hurdles to the Democrats’ re-election to the presidency in 2024.
“Splitting Congress” is already the best choice for the Democratic Party

  Midterm elections in the United States are held every four years during the general election. Since members of the House of Representatives serve two-year terms and members of the Senate serve six-year terms, this midterm election will re-elect all members of the House of Representatives and one-third of the senators.
  The Biden administration has been battered by the issue of inflation. Previous polls have shown that the Democrats will have a high probability of losing control of both the House of Representatives and the Senate. As a result, the Democrats only lost control of the House of Representatives, which is already better than expected. On the other hand, the Republican Party lost the House of Representatives amidst optimistic voices, and did not set off a “red wave.”
  As the White House national security adviser Sullivan said, “Biden feels very good about the midterm election results, and he feels that this foreign visit will help him, which gives him an excellent opportunity to deal with competitors with a strong posture. It can also unite allies.” US President Biden visited Africa and Asia successively during the mid-term elections, and participated in a series of multilateral and bilateral meetings such as the G20 summit.
  Moreover, from historical experience, the general president’s party is easy to lose in the mid-term elections. From this point of view, the performance of the Republican Party in this mid-term election is also lower than expected.
Figure 1: High U.S. fiscal deficit in the post-epidemic era

Data source: Haver, CICC Research Department

  Some people believe that the high-profile behavior of former US President Trump during the mid-term elections caused the Republican Party to lose points. Before the mid-term elections, many Republican candidates tried to take advantage of Trump’s popularity. These candidates advocated that if they were elected, they would re-examine the 2020 general election. These people also received Trump’s high-profile support. But contrary to expectations, these candidates all lost the election. Instead, the popularity of some Republican candidates who did not receive Trump’s support, such as Florida Governor DeSantis, soared.
  CICC pointed out that since 1960, the party to which the president belongs has lost an average of 23.8 seats in the House of Representatives and 2.7 seats in the Senate in mid-term elections. High inflation and growth pressures ahead of the election have kept Biden’s approval ratings low. Although the Republican Party won back the House of Representatives this time, it is difficult to form absolute dominance because of the lack of obvious advantages.
Fiscal and tax policies will be subject to greater constraints

  However, judging from the power struggle in the mid-term elections, the Republican Party has at least gradually regained some policy control, adding more weight to the 2024 general election.
  The U.S. House of Representatives has its own powers and responsibilities. The U.S. Constitution stipulates that all tax-related bills, appropriation bills, or authorized expenditures of federal funds need to be proposed by the House of Representatives, so that the House of Representatives has more say in fiscal and taxation; The Senate has the right to confirm members of the president’s cabinet and justices of the Supreme Court, and diplomatic agreements reached by the president of the United States and other countries also need to be approved by the Senate before they can finally have legal effect.
  From this point of view, the House of Representatives controlled by the Republican Party may hinder the subsidies and fiscal stimulus advocated by the Biden administration, which may further increase the risk of a U.S. economic recession in the next two years.
Figure 2: US Debt Ceiling Looming

Data source: Haver, CICC Research Department

  Historically, if an economic recession occurs during the presidency (especially in an election year), it is highly likely that it will be difficult to be re-elected. For example, in 2020, the United States fell into a sharp recession due to the impact of the epidemic, and the annual economy fell by 3.5%. The Republican Trump lost to the Democrat Biden in the re-election; It fell into recession in the second and third quarters, and then Democratic President Carter lost to Republican Reagan in the re-election.
  The current US economic predicament is similar to that around 1980, both facing the threat of high inflation. In 2022, the Fed has raised interest rates sharply at a rate not seen in many years. As of November 20, the Fed has raised interest rates by 375 basis points during the year, and the last four times have raised interest rates by 75 basis points. Although U.S. inflation has shown signs of turning downwards, it still far exceeds the target of the Fed as a whole, and there is a high probability that interest rates will continue to be raised in the future.
  However, after the Federal Reserve’s rapid tightening of monetary policy, the US economy has already shown a clear trend of slowing down. Since personal residential investment is highly sensitive to interest rates, the Fed’s rapid interest rate hikes have had a relatively negative impact on the housing market. It has fallen sharply in the last two quarters. The quarter-on-quarter annualized rate of residential investment in the third quarter was -26.4%, and this alone contributed 1.4% to GDP growth in the current quarter. U.S. 30-year home mortgage rates have soared above 7%, higher than before the 2008 financial crisis and up about 4 percentage points from the start of the year.
  U.S. consumption has also started to weaken. In the third quarter, U.S. personal consumption expenditures grew at a quarter-on-quarter annualized rate of 1.4%, down 0.6 percentage points from the previous quarter, almost the lowest since the economic recovery after the epidemic. Commodity consumption, in particular, has experienced negative growth for three consecutive quarters.
  If the U.S. economy does fall into recession in 2024, not only will monetary policy become loose again, but a certain degree of fiscal stimulus will also be required to avoid a more substantial economic downturn. At this time, members of the House of Representatives controlled by the Republican Party can stumbling on fiscal policy, and the risk of the Biden administration’s economic loss will greatly increase.
  After Biden took office in 2021, he implemented a fiscal stimulus of US$1.9 trillion and passed a US$550 billion infrastructure bill. This is an important guarantee for the smooth recovery of the US economy after the epidemic in 2021. Up to 12.4%.
  Another important economic game point is the US debt ceiling. At present, the scale of US public debt is as high as 31.3 trillion US dollars, approaching the legal debt limit of 31.4 trillion US dollars. This cap was just raised in December 2021. CICC believes that referring to the issuance speed of U.S. Treasury bonds in the past year, it only takes two months, and the U.S. debt will hit the debt ceiling of 31.4 trillion U.S. dollars in the first quarter of 2023. The debt ceiling is at risk in the second half of 2023, as the Treasury has around $500 billion in cash reserves, plus some contingency measures to sustain it for about two quarters after it is hit.
  August 2011 was the closest to a default on U.S. debt. It was not until the last few hours that Congress passed the debt ceiling. For this reason, S&P also downgraded the sovereign rating of U.S. debt. In 2011, the second half of the Obama administration’s first term, Republicans also controlled the House of Representatives.
  Of course, the probability of a U.S. debt default is extremely low, but it does not rule out that the Republican Party will use the debt ceiling as a bargaining chip in exchange for the support of the Democratic Party in other areas.
  In short, under the “divided Congress”, the policies of the Biden administration will certainly not be as smooth as in 2021-2022. The policy game may become the focus of the US economy in the next two years, and it will also add some uncertainty to the market .

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