Wall Street zeros in on Georgia runoffs

Wall Street traders are closely watching Tuesday’s runoff elections in Georgia, which will determine control of the Senate and the overall balance of power in Washington for the next two years.

Stock markets have soared since the elections, buoyed by the approval of two COVID-19 vaccines and the passage of a $900 billion relief and stimulus package.

But the prospects of a Democratic sweep in Georgia could have major implications for markets, affecting everything from corporate tax rates and regulations to more coronavirus relief.

Though the two Senate races are considered toss-ups, Republicans have an edge in the sense that they only need to win one of the two elections to keep control of the Senate. Those odds have led markets to price in a GOP majority in the Senate for the next two years.

“I would say that if the Republicans win one or more seats, nothing changes,” said Michael Cembalest, chairman of market and investment strategy at J.P. Morgan Asset & Wealth Management.

“If the Democrats win, markets will be on edge until they see what kinds of policy choices it leads to.”

Markets have been on a tear after tanking in March, when the COVID-19 pandemic took hold. The rally was fueled by a combination of broad fiscal stimulus, cheap money from the Federal Reserve and optimism for a swift recovery once vaccines are widely distributed.

The S&P 500 closed out the year at a record high, gaining 16 percent, while the Dow Jones Industrial Average also set a record with a 7 percent gain in 2020. The tech-heavy Nasdaq shot up an astonishing 44 percent.

But 2021 has already opened with some concern, with the Dow falling as much as 600 points during Monday’s trading on fears that asset prices are overinflated. The results of Tuesday’s runoffs pitting Democrats Jon Ossoff and the Rev. Raphael Warnock against Republicans Sen. Kelly Loeffler and former Sen. David Perdue, respectively, are likely to further shape this year’s outlook.

Democratic control would improve the prospects of a slew of bills to advance President-elect Joe Biden’s agenda on issues like health care, transportation policy and trade relations.

But Cembalest noted that even if Democrats win, their extraordinarily narrow margins mean that broad, sweeping changes that often rattle markets are unlikely over the next two years.

“If you combine a 10-seat edge in the House and a 50-seat majority in the Senate, it would easily qualify as the narrowest majority in history, so it’s much harder to pass policies unilaterally, and you have to compromise a lot,” he said.

“I think Biden’s agenda that he ran on will be much more difficult to get through Congress.”

For example, when it comes to tax policy, Senate Democrats might be able to persuade moderate Democrats to increase income rates on the richest Americans, but perhaps not a similar tax hike for major corporations or changes to taxes on capital gains.

“I would think Biden might be able to get a quarter or a third of his original tax bill through budget reconciliation,” Cembalest said.

The thin majorities Democrats would hold in both chambers under a Democratic sweep apply to issues across the board, especially in the Senate, where 60 votes are required to pass most legislation.

Certain tax and spending legislation can be passed through a process called budget reconciliation that only requires a simple majority.

Slim Democratic majorities would pose challenges for economic priorities like another round of COVID-19 relief.

“We expect the partisan environment under a split Congress to make passing further short term fiscal support and reform very difficult,” said Stephanie Kelly, senior political economist at Aberdeen Standard Investments.

“Even if there is potential for compromise, short-term fiscal support would still be much larger under a clean sweep than even under a constructive split-Congress scenario.”

That could also affect the emergency unemployment benefits that were extended just in the nick of time last month and are serving as the sole support for millions of people who have lost jobs due to the pandemic. The benefits are set to expire between mid-March and early April, as are additional weekly payments of $300.

Biden has repeatedly called the $900 billion coronavirus relief bill signed in December a “down payment,” and Speaker Nancy Pelosi (D-Calif.) has made $160 billion in state and local aid a top priority.

If Senate Majority Leader Mitch McConnell (R-Ky.) remains in control of what legislation comes to the floor, he is unlikely to agree to any such aid without including liability protections for small businesses. A Democratic-run chamber might be able to more easily find a compromise with a handful of moderate Republicans and have the power to put the bill on the floor despite McConnell’s objections.

While taxes and stimulus are the areas of most immediate concern to many on Wall Street, the congressional majorities will affect other important issues over the next two years.

Kelly forecasts that the Biden administration could lead to $3 trillion in new spending, paid for by $2 trillion in new taxes.

Cembalest says control of the Senate could make a substantial difference on how much is spent on infrastructure, a major economic driver.

“If the Democrats control the Senate, I would think about a bigger bill closer to $1 trillion that does not just include roads, bridges and tunnels, but schools and hospitals. If you have GOP control of the Senate, you’re talking about a smaller bill, maybe $500 or $600 billion, focused on surface transport and funded by a fuel tax,” he said.

However, Brian Gardner, chief Washington policy strategist for the investment bank Stifel, argues that tight margins for either side will mean there’s little difference regarding what gets done in the Senate.

“The difference between a 50-50 Senate and a 51-49 Senate on the ability to pass legislation is small,” he said.

“On infrastructure, Congress will probably reauthorize the five-year surface transportation bill with some modest increase in spending, but disagreements over spending priorities and funding will limit the scope of anything that Congress approves,” he said.

There are several other important ways that Senate control could affect Biden’s economic policy.

President Trump on Sunday renominated Judy Shelton for the Federal Reserve board, a nomination that will surely fail if Democrats win even one of the two runoffs Tuesday.

Similarly, Biden has yet to name his nominee for attorney general, a Senate-confirmed position that could oversee key economic policy on issues such as antitrust. A Democratic-controlled upper chamber could give him leeway to nominate a more progressive nominee to fill the post, a move that would likely strike fear into some parts of corporate America.

If the GOP loses its Senate majority, it will also lose much of the oversight powers it would otherwise enjoy, though a recent court ruling could still give them some room to seek information.

Markets tend to do best during periods of divided government, meaning a Democratic sweep could lead to a drop in the market.

“If that happens then equity markets might sell off on fears that Democrats would be able to use their majority push through Congress an agenda that is more aggressive than the market has currently priced in,” Gardner said.

But given the narrow margins, he added, such a downswing would probably be an “overreaction.”