Though analysts have been wrong before, many observers expect the Democrats to claw back some political power in this week’s midterm elections. Despite that, Wall Street is expecting President Trump to double down on some of his less popular policies, following the vote. At the time of writing, Harvard University’s polling gives a 96% chance that the Democrats take the House, and a 78% likelihood of the Democrats taking both the House and the Senate. Goldman Sachs, for example, wrote to clients this morning that it expects President Trump to increase tariffs in the event the Democrats secure greater Congressional influence. Economists Alec Phillips and Abhay Duggirala reasoned that “Democrats have indicated they would seek to reverse some of President Trump’s tariffs, but we expect this to have a limited effect since the reversals would likely be focused on a few countries (e.g., Canada) or products.” “We expect President Trump to announce new tariff increases after the election that would more than offset those reductions, likely resulting in a rise in the US effective tariff rate of a little under 2pp.”
Tariffs will also likely become an increasingly important revenue source in the coming months. The conflict in the Middle East, for example, is proving costly, and sits against a backdrop of $40 trillion in national debt with calls from budget hawks to reduce deficits to 3% of GDP from its current 6%.
But any efforts to reduce these deficits will likely get bogged down in a more divided government, according to ING’s James Smith. He wrote to clients that fiscal gridlock will likely push attention back to trade policy and how to squeeze more revenue out of import relationships.
“Remember tariffs?” Smith wrote. “After the Supreme Court struck down Trump’s emergency tariffs, temporary 10% blanket rates ultimately gave way to a more permanent structure under Section 301. The issue has since slipped remarkably far down the agenda.”
Iran action
The White House’s course of action in the Middle East, post-midterms, remains an unanswered question. As UBS’s Paul Donovan described it, the president may become more aggressive in the Gulf war “once freed from the pursuit of popularity.”
According to a Pew Research study last month, just 14% of voters said they strongly approve of President Trump’s handling of the military conflict with Iran, with a further 20% said they “somewhat” approve. With voters disenchanted, Trump’s only remaining motivations for the conflict lie in national security and his personal legacy.
“Where markets will want to focus is on the Republican reaction to the results,” said Donovan. “Does the Republican Party divide over MAGA-related issues, and does President Trump escalate hostilities in the Gulf War with wider economic consequences at home and abroad?”
More broadly, the cost of paying for the action settles into longer-term divisions about the future of government spending. Recent reports on the costs of the Iran war now come to $47 billion, with the conflict initially outlined as a matter of weeks now stretching into months.
“Republicans will likely attempt to pass a reconciliation bill along party lines in the coming weeks that could add substantially to defense spending and potentially address the debt limit, which will have to be dealt with before the late summer/fall of next year,” Deutsche Bank wrote to clients on Friday. “Recall, also, that federal government funding runs out on December 11 which will require bipartisan support for a continuing resolution to prevent a shutdown.”
Trump signed the Continuing Appropriations and Extensions Act on September 2, which funded federal agencies through a 72-day window to December 11.
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