Due to the frantic melee of the insurrection on the Capitol, and the subsequent impeachment process, it is easy to miss the more consequential news of the last week. The Democrats, in a previously ruby-Red state, have won two Senate elections in Georgia.
In the long-term, this presages the long-awaited shift of the Deep South trending Democrat. On a more here-and-now basis, it means that the Democrats control the trifecta of federal government: the House, the Senate, and the Presidency.
In a 50-50 split Senate, the Vice-President, Kamala Harris, now wields the tie-breaking vote that will surely determine many a future split to come.
What does this actually mean though?
Well, on a simple level, the Democrats now control the Senate. This grants them control of the legislative calendar, as well as that of committee chairmanships. More importantly, it will allow Biden to be significantly more ambitious with his appointments, and with his manifesto policies.
Analysts at Goldman Sachs argue that this will allow the Democrats to add $600bn of stimulus spending. In particular, the additional $2,000 cheques are at the front of the queue; as incoming senate majority leader Chuck Schumer writes to democrats, these are “one of the first things we want to do once our new Senators are seated”.
What’s been the short-term impact?
On the bond markets, US bonds faced a sharp sell-off, with the yield on the 10-year Treasury increasing 0.07 to the highest level since March. This demonstrates that the market is pricing in significantly greater degrees of government borrowing than what was expected prior to the Senate elections.
Meanwhile for the stock markets, there has been a similarly strong impact, with “value” sectors worldwide benefitting. Value stocks such as banks, materials, and energy are disproportionately likely to benefit from increased infrastructure spending as a result of the impending fiscal stimulus.
Even with the chaos at the Capitol, the S&P500 ended 0.6% up on the day, indicating the strength of positive sentiment.
One analyst, Ben Laidler of Tower Hudson Research, notes that “the stocks that are most driven by [a fiscal stimulus] are companies in cyclical industries and small-caps, where earnings have been more depressed”.
This impact can be seen globally – the Russell 2000 index and the FTSE 100, both with a high weighting of “value” stocks rose 3.7% and 3.5% respectively after the Georgia Senate elections.
Similarly, Goldman Sachs has backed the DAX and the FTSE 100 to do well this year, riding on the back of this fiscal stimulus.
Is there a potential downside?
This extra stimulus will have to be paid for somehow in the future. And, with control of the Senate, it might now be easier for the Democrats to pass higher corporation taxes, as well as higher personal income taxes for high earners.
These policies formed a flagship part of Biden’s election proposals, and they’ve now become significantly easier.
Moreover, depending on the way you look at it, Biden’s increased strength will allow him to engage in greater tech regulation. Biden’s chief technology advisor, Bruce Reed, is particularly known for pushing for increased control. Reed has sought to push against Section 230, a law preventing people from suing internet companies over the content of their postings.
Tech companies may well find that a Biden administration is far less supportive than the previous one, which might explain the movement towards “value” away from “growth” stocks in recent weeks. An interesting pre-emption of this can be seen in the more activist self-regulation of media content by technology firms.
This is not just limited with Trump’s twitter ban, but extends to the Apple Store removing Parler from its platform.
How are hedge funds responding?
Interestingly, some hedge funds are following the same pattern, engaging in “reinflation” bets. This is where they predict that an incoming stimulus package will result in a pick-up in inflation by betting on long-term US Treasuries relative to short-term bonds.
One example of this is Brevan Howard, while Wells Fargo argues that the benchmark 10-year yields might rise to 1.2 per cent by the end of the month.
It seems clear, therefore, that much of the market is moving coherently in response to the Senate elections – a Democrat trifecta will result in higher economic growth, and more inflation.
What are the limitations?
Namely, the Democratic caucus is hardly united around the Progressive bloc, and there are a number of conservative Democrats that are likely to prevent a hard shift to the left.
In particular, Joe Manchin of West Virginia and Kyrsten Sinema of Arizona are two Democrats who will be looking towards hard-fought re-election bids over the next two cycles, and hence will be unwilling to tie their sails too closely to the Progressive left.
The success of Biden’s platform, and the ability to pass the fiscal stimulus the market expects, will hence still be largely determined on how able Biden is to work with those across the bench to moderate Republicans such as Susan Collins, while also keeping on board conservative Democrats.
Biden’s position is certainly easier than it was two weeks ago, but it is not the overwhelming one that would be needed for the passage of very Progressive legislation.
Regardless of this – it is clear that these Senate elections will have clear ramifications on markets, not just in the US, but throughout the world.