Big Midterm Gains Threaten Wall Street’s Hope Of A Split Government

Following last week’s midterm vote, Wall Street had expected a split government, with Republicans taking charge of the House, Senate, or both. Much to their surprise, a stronger-than-expected showing by Democrats may force investors to rethink the scenario they had expected regarding the cryptocurrency market.

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Why Wall Street favors split government?

A split government could stimulate Democrats from pushing through several large fiscal packages, including $369 billion in spending on climate and energy policies, and enacting a windfall tax on oil and gas companies, analysts at UBS Global Wealth Management wrote earlier this month.

Wall Street views the split government as a favorable condition partly because some investors believe it makes major policy changes more difficult to achieve.

Still, “Federal Reserve policy, rather than fiscal policy, will remain the main driver of markets in our view,” they said.

In the same tandem, analysts at Morgan Stanley reported before last week’s election that Democrats expanding their majorities in Congress could lead markets to “assign a higher probability to further fiscal expansion, with Congress and the Fed effectively pulling in opposite directions on inflation.”

Chances Of A Split Government?

Democrats held onto control of the U.S. Senate while Republicans remained close to seizing control of the House of Representatives as officials continued counting ballots. As of now, while a Democratic sweep is still seen as unlikely at this point, perceptions that such a result is within the realm of possibility could ignite worries over spending and legislation that many investors had put to rest. 

The chief global strategist at LPL Financial, Quincy Krosby believes if more power rests with Congress for Democrats, it may pit fiscal and monetary policy against each other, potentially delaying the Federal Reserve’s efforts to fight inflation. She asserted, “If the goal is to curtail demand, we could now have policies that underpin demand.”

As of early Sunday, Republicans had won 211 seats and the Democrats 205, with 218 needed for a majority.

Investors are worried about spending as they believe it could buoy inflation and potentially force the Fed to ramp up their market-punishing monetary tightening policies. The inflation data last week stimulated hopes the Fed could temper its rate hikes, sparking a sharp rally in stocks and bonds.