US Watch. The 2018 Midterms Three scenarios. Group Economics Financial Markets Research. Insights.abnamro.nl/en. 28 September 2018

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1 US Watch Group Economics Financial Markets Research 28 September 218 The 218 Midterms Three scenarios Bill Diviney Senior Economist Tel: bill.diviney@nl.abnamro.com Our base case is that the Democrats will win control of the House this November, with Republicans retaining the Senate This would reduce the President s legislative power, and raise the prospect of impeachment but not necessarily removal The main risk scenario is that Republicans retain both majorities which would raise the prospect of a new round of fiscal stimulus This would have significant implications for the growth outlook, Fed policy, and markets with the risk of an overheating scenario Alternatively, a Democratic sweep would increase the chances of the President s removal before his term finishes Introduction The midterm elections take place on 6 November. At stake is control of both the House (all 435 seats contested) and the Senate (33 of seats contested), and the outcome will decide whether President Trump is able to execute further on his agenda, and potentially even, whether he survives the full term of his presidency. At present, President Trump s Republican Party holds slim majorities in both the House and the Senate. The small majority in the Senate has sometimes challenged the President s agenda, particularly the reform of Obamacare. However and more importantly for the economic outlook the president has been able to push through the biggest reforms to the tax system in decades, as well as a highly unusual degree of fiscal stimulus for such a late stage in the economic cycle. President Trump s approval remains poor helping the Democrats lead in opinion polls Net presidential approval ratings, pts % Democrat lead over Republicans Net presidential approval ratings, pts Jan-17 Jul-17 Jan-18 Jul-18 President Trump job approval, net Feb-17 Aug-17 Feb-18 Aug-18 Democrat lead Trump approval (rhs, inverted) Insights.abnamro.nl/en

2 2 US Watch - The 218 Midterms Three scenarios - 28 September 218 Should the Republican Party lose either the House or the Senate, it will become much harder going forward to legislate, thereby limiting the President s power. This could have significant macroeconomic implications, as the Republicans are likely to want to pass further stimulus measures once the current round of stimulus runs its course in the second half of 219. Recent polling Democrat lead has widened again On a national basis, the Democrats have held a persistent lead over Republicans in opinion polling since 216 s presidential election, and as of September, that lead stands at around 8 points. The polling lead of Democrats tracks President Trump s approval ratings remarkably closely, suggesting more establishment Republicans will struggle to distance themselves from a President who is historically highly unpopular. Indeed, while President Trump s net approval rating improved through most of 218, it remains low in comparison to former presidents at this stage of the presidency. More recently, it began falling again after the conviction of his former lawyer and campaign manager, and the revelations (for instance from Bob Woodward s book) suggesting a highly dysfunctional administration. While it has since recovered somewhat, his most recent net approval rating of c.-9pts continues to suggest a high likelihood of Democrats at least winning control of the House. President Trump is historically unpopular Presistent Democrat lead since Trump s inauguration Net presidential approval ratings, pts % supporting Dems / Republicans % Democrat lead over Republicans Year 1 Year 2 Bush Jr Obama Trump Feb-17 Aug-17 Feb-18 Aug-18 Democrat lead (rhs) Democrats Republicans Translated to seats, and based on projections from RealClearPolitics, opinion polling points to at least 26 seats in the House of Representatives that are likely to go to Democrats against 19 that are likely to go to Republicans, with 39 marginal or toss-up seats. In the Senate, in contrast, because only 33 of seats are actually being contested and Democrats already hold 24 of these the chances of Democrats gaining a majority are notably lower. Current projections are for 47 seats likely to go Republican vs 44 for Democrats, with 9 marginal seats. Thus, the Republicans need to win fewer of those marginal seats to gain a majority than the Democrats would. Three main scenarios So far, based on the above projections, the most likely outcome is that the Democrats win the House, while the Republicans retain the Senate. This is our base case scenario, and the one upon which our 219 macroeconomic forecasts are based. But what would happen if the Republicans retained both the House and

3 3 US Watch - The 218 Midterms Three scenarios - 28 September 218 the Senate? Or if the Democrats won both? Below, we will explore each scenario in turn. Base case (5%) Democrat win (25%) Republican win (25%) Scenario Democrats win control of House, Republicans retain Senate Democrats win both House and Senate Republicans win both House and Senate Sharp slowdown by 22, as fiscal Growth Same as Base stimulus fades in late 219 High risk of impeachment, low risk of Higher risk than in the base case, Impeachment removal but removal risk still low Above trend growth to persist into 22, should additional fiscal stimulus be passed Very low risk Fed Rate hikes continue to June 219 Rate hikes continue to June 219 Rate hikes continue into 22 Markets -Risk sentiment: Neutral -Risk sentiment: Mild negative -Treasury yields peak at 3.% in -Treasury yields fall on higher 218, decline to 2.8% by end-219 uncertainty -EUR/USD rises to 1.25 by end -Dollar weakens more than in our 219 base case scenario -Risk sentiment: Initially positive -Treasury yields peak higher than in the base case -Dollar initially strengthens, then weakens sharply in 22 Source: ABN AMRO Group Economics Base case (5%) - Democrats win House, Republicans keep Senate With Democrats taking control of the House, the President s legislative freedom would be significantly curtailed. Republicans would need to reach across the aisle to get Democratic support for legislation, and the President would have to rely more on Executive Orders (which do not require congressional approval) to implement policy. There is also a higher risk of the debt ceiling stalemates that featured prominently through the Obama presidency. In short, there would be much less chance of bold, sweeping legislation on the scale of the tax cuts and fiscal expansion we have had so far in the Trump presidency. There are other political implications. With a House majority, the Democrats could launch impeachment proceedings, perhaps on the grounds that he allegedly directed his former lawyer Micheal Cohen to pay illegal hush money to Stormy Daniels. This would not automatically mean President Trump s removal from office. For that, a 2/3 majority in the Senate would be required, meaning Democrats would need Republicans to turn against the President. We think more serious charges (perhaps via the Mueller investigation) would have to be brought to the President for Republicans to support his removal. Democrat win (25%) - Democrats win both House and Senate This scenario would be quite similar to our base case, but the political fall-out for the President of losing both the House and the Senate would likely be greater. Depending also on the President s approval ratings at the time, some Republicans would be more likely to turn against the President, raising the risk that they join Democrats in voting for his removal in any impeachment proceedings. While it would still probably take something very significant to get a 2/3 Senate majority in favour of his removal, the bar would likely be lower than in our base case scenario.

4 4 US Watch - The 218 Midterms Three scenarios - 28 September 218 Polling suggests Democrats will win the House Number of seats in House and Senate Impossible to remove Trump without Republicans Number of seats in House and Senate Current composition of Congress Majority threshold 218 election projections House Senate House Senate Democrat Independent / Marginal Republican Senate seats needed to remove President Trump 51 seats 47 seats Maximum potential win in November midterms Realistic Democrat win scenario 2 seats Republicans Democrats Independent Source: ABN AMRO Group Economics Source: RealClearPolitics, ABN AMRO Group Economics Republican win (25%) - Republicans keep both House and Senate Arguably the most important implication of Republicans retaining both the House and the Senate, would be the potential for additional fiscal stimulus once the current round runs its course in the latter half of 219. At present, we foresee the economy slowing significantly towards the end of 219 and into 22. With an eye on the 22 presidential elections, and with concern among the public over the deficit much lower than it was in the Obama presidency (see chart), we believe Republicans would push for increased deficit spending to sustain economic momentum leading into the elections. In other scenarios where the Democrats have full or partial control of Congress, such a fiscal expansion would be far less likely, in our view. In this scenario, we would see upside risks to growth in 22, which we currently expect to be below trend. Additional stimulus at such a late stage in the cycle would raise overheating risks, which the Fed would likely be inclined to respond to with further rate hikes. This could culminate in a classic boom & bust scenario with a recession perhaps in 221. A further implication would be a significantly reduced chance of the President being impeached and removed, all else equal. We think the Mueller investigation would have to throw up something truly damning of the President for Republicans to both launch impeachment proceedings and vote en masse for his removal. Less public concern over the deficit could clear the way for another round of stimulus % of respondents % qoq saar Reducing budget deficit a top priority 8 Forecast Jun-7 Dec-9 Jun-12 Dec-14 Jun-17 Dec-19 GDP Government spending Source: Pew Research Center, ABN AMRO Group Economics

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