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Split Congress could pay dividends for economy, stock market

FILE - A security guard is seen next to a road block near the New York Stock exchange, Friday, Jan. 14, 2022, in the Financial District.  (AP Photo/Mary Altaffer, File)
FILE - A security guard is seen next to a road block near the New York Stock exchange, Friday, Jan. 14, 2022, in the Financial District. (AP Photo/Mary Altaffer, File)
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A potentially split Congress could be a positive development for a U.S. economy that has dealt with sustained inflation for months and businesses preparing for an possible economic downturn next year.

Democrats secured control of the Senate over the weekend with the reelection of Nevada Sen. Catherine Cortez Masto. There is still a chance for Democrats to retain their House majority, though Republicans are favored to win the House by a slim margin and split the two chambers.

A split Congress would be sworn into office as the economy is still working its way out of an inflation shock that prompted the Federal Reserve to raise its benchmark rate at the fastest pace in decades.

Last week’s consumer price index gave economists some hope the U.S. may be turning the corner on inflation after it came in below expectations at 7.7% year-over-year in the smallest annual gain since February. Core inflation, which excludes volatile food and energy prices, also came in lower than expectations.

Markets on Wall Street soared after the inflation report Friday as investors hoped it could prompt the Fed to slow the pace of interest rate hikes.

While difficult economic debates are guaranteed with the issues facing the U.S. and its leaders, gridlock and forced compromises can have a positive effect on markets and economy at large.

With Democrats having long odds to have full control of the government, new broad spending bills and tax increases are less likely to come to fruition. The lack of extreme movement in either direction gives businesses and investors more clarity about what to expect from Washington.

A Republican House could also incentivize President Joe Biden and congressional Democrats to reach across the aisle to enact new legislation.

Having a split Congress would likely slow and diminish the chances of an economic stimulus package being passed in the event of a recession but it could still present an opportunity for legislation to help American businesses such as tax cuts tied to hiring people at a time when unemployment could rise in an economic downturn.

“President Biden should stress that moderates on both sides won, and he can't wait to reach out across the aisle,” said Farrokh Langdana, professor of finance and economics at Rutgers Business School. “He should not demonize the Republicans, he should dangle tax cut talk for them, and they will be trapped. They really have to rise to the challenge because someone dangles tax cuts and they don't rise to that; they will then look bad because that's their big mantra — tax cuts — and they will actually help. This is not just a political thing.”

Unemployment rates have hovered near historical lows throughout the year as businesses continued to hire in the face of inflation and tightening by the Fed. There have been signals the labor market is beginning to loosen and that could continue as inflation remains above the Fed’s goal of 2% year-over-year and forces more people to reenter the workforce.

“Pushback on (Biden’s) spending was good. He is going to get more pushback or similar pushback from the Republicans,” Langdana said. “Now the big issue is going to be unemployment. The best thing you can do is work with them.”

Markets have historically gone up after midterm elections regardless of which party takes power. Since World War II, the S&P 500 has been higher a year after the elections with an average return of about 13%, J.P. Morgan said in an investment note last week.

One of the biggest risks of the split government is a standoff on raising the debt limit, which is expected to come in the first quarter of next year. Some Republicans have threatened to use the increase to force the White House to scale back spending or tax increases passed in the last Congress.

Economists and lawmakers have warned of catastrophic consequences from a default by failing to raise the limit. Some Democrats have pushed for passing a bill in the upcoming lame duck session while the party still has control of the House.

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“My hope would be that we could get it done in the lame duck,” House Speaker Nancy said in an interview on ABC’s “This Week.” “We'll have to, again, lift the debt ceiling so that the full faith and credit of the United States is respected.”

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