About this episode
Looking back on the 2016 and 2020 elections, it is clear that elections can have a significant impact on the U.S. economic outlook. The question is whether the coming midterm elections have any meaningful implications. Head of U.S. Public Policy Research and Municipal Strategy Michael Zezas and Chief U.S. Economist Ellen Zentner discuss. -----Transcript----- Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Head of U.S. Public Policy Research and Municipal Strategy for Morgan Stanley. Ellen Zentner: And I'm Ellen Zentner, Morgan Stanley's Chief U.S. Economist. Michael Zezas: And on this special edition of the podcast, we'll be talking about the 2022 U.S. midterm elections and the potential impact on markets and the economy. It's Wednesday, June 1st, at 10 a.m. in New York. Ellen Zentner: Michael, I'm going to start us off here because 13 states have now completed their primaries ahead of the midterm elections. And as our key Beltway observer, I'd love to get your initial impressions. There's a fair amount of belief that Democrats will have a difficult time maintaining majorities in both houses of Congress and maybe some investor complacency around this sort of outcome. So what are you hearing from investors and how should they be thinking about the midterms? Michael Zezas: Yeah. I think the word complacency is the correct word to use here. I think in some ways this election hasn't gotten as much attention as it should because in prior elections there was a big macro issue at play, whether it be tax cuts and trade policy in 2016, or in 2020 whether or not another tranche of COVID stimulus aid could get approved based on the election outcome. This election, we think the outcomes will really drive more sectoral impacts. So whether or not tech regulation becomes possible or regulation around cryptocurrency, or could there be a path toward spending more money on renewables and traditional energy exploration. And then, of course, corporate taxes. And then when you couple that with polls and other items suggesting that Republicans are very likely to take control of one or more chambers of Congress, it's easy to put this issue aside and become complacent about it. But Ellen, this focus on the micro doesn't necessarily mean that the outcome doesn't matter for the macro, i.e., the U.S. economic outlook. Can we look back a bit to some prior elections and how they changed the trajectory of your economic outlook? Ellen Zentner: So, you know, I would start with 2016 where we had a Republican sweep and that led to the Tax Cut and Jobs Act being passed. It was a significant increase in the fiscal deficit and a good deal of stimulus to the economy. And so we really saw that bear out in 2017 where you already had a late cycle dynamic. At the time we called it ill timed policy, where you're throwing stimulus at the economy, when the economy doesn't really need it, you really want to do the majority of your fiscal stimulus when you're actually in a downturn. Trade policy then followed. And of course, late in 2018 started to really bite the global economy. And that's when we saw the Fed also move,v to the sidelines and start cutting rates because they saw a big slowdown in the global economy that was also hitting the U.S. economy. So fiscal policy there had both an uplifting effect and a depressing effect in the outlook. And then I would point to 2020 where the election outcome really opened the door for further fiscal stimulus related to COVID. So we had already done rounds of significant fiscal stimulus, but then in a Democratic sweep, you had two further rounds of fiscal stimulus related to COVID. And so that also had a very big effect on shaping the economy in terms of the excess savings that households were building up and the amount of excess money in the economy. And so I think those are the two best examples, of course, the two most recent examples. Michael Zezas: So a common thread between 2016 and 2020 was that the outcome had one party in control of both chambers of Congress as well as the White House. And it's long been part of our framework that one party control is a prerequisite for Congress providing proactive fiscal aid to the economy. So let's say the conventional thinking about this election is correct and the Republicans pick up control of one or both chambers of Congress. Then we'd expect that Congress would be more reactive to economic conditions than proactive, basically, that the economy would have to demonstrably worsen before you'd see Congress deliver aid. Would that shift in dynamic mean anything to your US economic outlook? Ellen Zentner: I mean, our baseline outlook fiscal policy is really not a big factor. The biggest factor coming from fiscal policy has already passed. So late last year we passed a significant infrastructure spending bill and while at the time that had a market impact, it doesn't really have an economic impact until about four quarters later when the bulk of those funds hit the economy. And so that's something that starts to lift growth in the fourth quarter of this year, we estimated by about 3/10 lift to GDP from those funds going out. Otherwise, in our baseline outlook, fiscal policy is just not a big factor. I think when we think about our bear case where we actually have a recession, that would be the first chance for fiscal policy to really kick in meaningfully. But even there, because we don't expect the downturn to be very deep, we expect nothing more than, say, the automatic stabilizers that typically go in to support the economy when jobless claims are rising, and the unemployment rate is rising and other economic factors are weakening. Finally, Michael, I want to ask you about election night and the days that follow. And I'm going to ask this because uncertainty around election outcomes also can impact the economy near term. So how likely is it we'll see the same sort of delays in vote tallies that we saw in 2020?. Michael Zezas: Yeah. I think investors should be on guard for a very similar time frame. The problem that drove this delayed tally in 2020 was the growth in use of vote by mail, and that really hasn't changed or is unlikely to change in our view. And of course, the problem is voting by mail, those ballots get tallied separately and sometimes later, as opposed to the machine votes which get tallied much quicker on election night. And like last time, it seems that Democrats tend to use vote by mail more than Republicans. So it creates this dynamic where on election night, initial leads could be misleading and you have to wait until the final votes are tallied in order to understand what the true margin is. So investors should prepare to wait a few days to fully understand, particularly if this is a close election, who is going to control the House of Representatives and who is going to control the Senate. That could create some volatile moments in the parts of the market that are most sensitive to these outcomes. Again, that's going to be sectors that are sensitive to corporate tax changes, tech regulation, crypto regulation and energy spending. Michael Zezas: Ellen, thanks so much for taking the time to talk with me. Ellen Zentner: As always, great talking with you, Michael. Michael Zezas: And thanks for listening. If you enjoy the show, please share Thoughts on the Market with a friend or colleague, or leave us a review on Apple Podcasts. It helps more people find the show.