Via Goldman Sachs' Jan Hatzius,
- The primary election campaign season unofficially concluded Tuesday (Aug. 19) with the outcome of the Alaska Senate primary, which was the last key nomination contest prior to the general election. While there were a few high profile surprises during the primary season, this year's primary elections do not appear to have affected the general election outlook to the same degree that primary outcomes have over the last couple of elections.
- The focus is now on the general election on November 4, where Senate Republicans hold 45 seats and need a net gain of six seats to win a majority. Recent polling shows Republican candidates leading by large margins in races for three Democratic-held seats, and by very slim margins in another four contests. While these early polls are not particularly reliable, overall they imply a tight race with a clear opening for Republicans to take a narrow majority of Senate seats.
- As the election draws near, the potential effects of a Republican Senate majority seem likely to become more of a focus for market participants. A slim Republican majority seems unlikely to us to meaningfully alter the outlook for major policy reforms, since Democratic support would still be necessary in the Senate and the President would still have the option to veto. That said, the details of more routine legislation could be affected. Uncertainty could also increase regarding high profile deadlines such as the debt limit or the expiration of spending authority; markets have gradually become accustomed to the way Congress has handled these deadlines, but a change in control could lead to some renewed uncertainty regarding these deadlines, at least temporarily.
In the four months since we last wrote about the upcoming midterm election, the outlook has changed only incrementally. Although there were a few surprising retirements and primary election results over the last few months, none of these seem to have significantly affected the overall prospects for control of the House or Senate.
As noted in our previous report, the composition of the House continues to look unlikely to change significantly due to an apparent lack of competitive seats and the absence of national political momentum sufficient to create a "wave" for either party. Regarding the Senate, most observers expect Republicans to gain at least four seats due to the composition of seats up for re-election this year and as a result of several Democratic retirements. While there is no formal consensus expectation, the average midpoint of the ranges projected by several well-known election forecasters rounds up to a six-seat Republican gain, i.e., just enough to win a majority.
Exhibit 1 demonstrates the challenge that Senate Democrats currently face: the recent average polling margin in each Senate seat up for re-election this year is shown on the horizontal axis and the two-party margin in the 2012 presidential election in that state is shown on the vertical axis. Democrats will have five open Senate seats where the incumbent is retiring. Three of these will be in states that voted heavily Republican in the 2012 presidential election --South Dakota, West Virginia, and Montana--and polling over the last several months has consistently favored the Republican candidates in these contests. Four Democratic incumbents are also running in states that voted Republican in the presidential election in 2012: Alaska, Arkansas, Louisiana, and North Carolina. Current polling suggests these races are close to even, with Republicans leading narrowly in three of them as well as in Iowa, which voted slightly Democratic in 2012. A few other Democratic seats beyond these appear fairly competitive, either because they are in states that tend to be closely split at the presidential level, or the incumbent is not running, or both.
Fewer Republican seats appear to be competitive. In part, this is because there are fewer Republican seats up for re-election at all: only 15, compared to 21 Democratic seats. It is also because, with the exception of Maine, which does not appear to be a close contest, there are no Republican seats up for re-election this year in Democratic-leaning states. That said, recent polling implies that contests will be competitive for Republican-held seats in Georgia, where the incumbent is retiring, and Kentucky, which has voted strongly Republican in recent presidential contests but where sparse early polling indicates a very close race.
As the election draws near, we have begun to receive more frequent questions about the implications of a potential Republican Senate majority. In general, we would expect the effect on policy outcomes to be fairly limited, since the government would still be divided, just in a different way than it was before:
1. There should be little effect on most of the major policy debates. Even if Republicans gain a slim majority in the Senate, they would still need Democratic support to reach the 60 votes usually necessary to pass legislation in that chamber. Just as importantly, President Obama could veto any legislation he opposed and Republicans would be far short of the 67 votes needed to overcome a veto. Many of the major policy items on the agenda, such as immigration reform, housing finance reform, or changes to financial, energy, or environmental regulation, would therefore still require a bipartisan agreement as they do today.
2. The policy specifics of routine legislation could shift incrementally. Although major reforms in most policy areas are no more likely to pass under a Republican-majority Senate than a Democratic one, control of the Senate majority could have an effect on more routine deadline-driven legislation. Examples in this area might include the extension of expired and soon to expire tax provisions (so-called "tax extenders") that Congress is likely to pass by early 2015 if not late this year, or the renewal of the highway program that needs to occur by May 2015. Republican majorities in both chambers might reduce the likelihood that revenue is raised from corporate tax changes to pay for these bills, for example.
3. Fiscal policy changes could reach the President's desk. Although most legislation would need to surpass the usual 60-vote threshold in the Senate, if Republicans won House and Senate majorities, they could use the budget “reconciliation” process to pass fiscal legislation through both chambers of Congress with only a simple majority vote. This procedural mechanism, which is tied to the annual budget process, has been used to enact significant fiscal policy changes in the past, including several rounds of deficit reduction legislation in the 1980s and 1990s, tax cuts in 2001 and 2003, and parts of the Affordable Care Act (ACA) in 2010. Changes to the ACA might be a focus for reconciliation legislation, and tax reform could theoretically be addressed using this process as well. That said, President Obama would still have the option to simply veto whatever legislation arrives at his desk and would presumably do so if the reconciliation process was used mainly as a way to circumvent Democratic opponents in the Senate. So while a potential Republican Senate majority might result in greater legislative debate on fiscal policy, it is much less likely to result in enactment of significant fiscal policy changes.
4. Uncertainty regarding fiscal deadlines could return. Markets have gradually become accustomed to the way Congress has dealt with events such as the debt limit, the "fiscal cliff," or the expiration of government spending authority: the House would often pass a bill seen as unlikely to become law, the Senate would then pass a compromise bill, which the House would accept, often at the last minute and relying on significant Democratic support. This pattern could change if Republicans took the majority in the Senate. For example, when the next debt limit increase becomes necessary in Q3 or Q4 of 2015, Republicans might try to use the reconciliation process noted above to couple it with other political priorities and pass it only with Republican votes in the House and Senate, potentially attracting a presidential veto. Spending legislation that will need to be renewed to avoid a government shutdown could become another source of uncertainty. In an interview this week, Senate Republican Leader McConnell said that under a Republican majority, "we're going to pass spending bills, and they're going to have a lot of restrictions on the activities of the bureaucracy. That's something [President Obama] won't like, but that will be done. I guarantee it." While the eventual outcome of these debates would presumably be the same as under the current composition of Congress--the debt limit is eventually raised, spending authority is eventually extended--it might take market participants time to get used to a new process.
5. Congressional Republicans and the White House might be able to find common ground on a narrow set of issues. There may be a few issues where congressional Republicans are closer than congressional Democrats to the Obama Administration's position. One of these could be international trade, where Congressional Republicans have tended to be more supportive of bilateral and regional trade agreements, such as the Trans-Pacific Partnership (TPP), which could be finalized late this year or next, or Trade Promotion Authority (TPA), which allows the administration to negotiate trade agreements subject to an up or down vote in Congress but no amendments and is seen as an important tool to pass TPP in Congress.