A Senate surprise leaves Democrats dreaming

With the resolution of the two Senate races in Georgia, Democrats now have complete but narrow control of the federal government.
January 2021

With the resolution of the two Senate races in Georgia, Democrats now have complete but narrow control of the federal government. This surprising turn gives President-Elect Biden the latitude to enact portions of his economic agenda including increased stimulus, a large infrastructure package, higher taxes and additional regulatory scrutiny. However, these measures will likely be scaled back versions of his campaign proposals.

Though much attention has been given to which party controls the Senate, we believe that the true constraint on the Democratic wish list will be the House of Representatives.  Democrats lost seats in the November elections leaving the more moderate members vulnerable, particularly those from suburban districts with constituents more fiscally centrist than the traditional Democratic base. Additionally, though Democrats will now control which bills come to the Senate floor for a vote, we expect them to keep the filibuster in place meaning most bills will require 60 votes to pass. Due to the 60 vote threshold, much of the legislation passed will require bipartisan support, a tall order in a deeply divided country. The Democrats’ primary Senate tool will be “reconciliation”, a budgetary process that allows a simple majority to pass legislation related to spending, taxing and the federal debt limit. Reconciliation is limited to once per year, so Senate Democrats will attempt to make these bills as wide-ranging as possible without losing any members of their party. Additionally, a bill passed in reconciliation can only affect the budget deficit for 10 years, so much of the spending will require a sunset clause after this period.

Biden administration priorities

The first priority of the Biden administration will be on the COVID-19 response and stimulus.  Prior to the Georgia Senate elections, our base case was for small and limited relief bills given Republican hesitancy to add to the debt. However, now that Democrats can move a more substantial bill to the Senate floor, we expect much more impactful stimulus to pass. Senate Democrats are keenly aware that their new Georgia colleagues made $2,000 stimulus checks a wedge campaign issue, so these additional checks will likely become the cornerstone of the new bill. In addition to stimulus checks, we expect that state and city governments will get funds they have requested to plug budget shortfalls. This could lead to an ultimate bill totaling close to $1 trillion, on top of the $900 billion COVID relief bill passed just in December.

The next item will likely be a large tax and spending bill that will be passed through the reconciliation process. We expect Congress to try to shoot many birds with one stone as Biden’s political capital will likely diminish as we move away from Election Day. We expect this bill may include up to $1 trillion in infrastructure spending as promised by Biden’s “Build Back Better” program. Additionally we expect funds for green energy, healthcare and education. In order to partially pay for this additional spending, Democrats will likely raise personal and corporate taxes. On the personal side, marginal rates for wealthy individuals will probably return to where they were before the 2017 tax cuts, with the top bracket back to 39.6%. The plan will also likely limit deductions and potentially raise capital gains rates for high income individuals. For the corporate side, we expect the headline tax rate to increase from 21% to 25% along with additional taxation on foreign earnings. Finally, to ensure big technology companies are paying taxes, a minimum tax will likely be installed to minimize the benefit of tax shelters. 

Democrats will also have an easier time enacting a more forceful regulatory agenda with their Senate majority. All chairmanships of the powerful Senate committees will pass from Republican to Democratic control, changing their agendas significantly. For example, the Senate Banking Committee chairmanship will pass from the business friendly Republican Senator Mike Crapo to the progressive Democratic Senator Sherrod Brown, with increased scrutiny for the financial services sector to follow. The installation of a more progressive cabinet officials and political appointees will also be easier as confirmation only requires a simple majority. We expect the new government to especially increase regulation in the areas of energy, banking and technology.

Foreign policy is another area where Biden will have more latitude. We expect him to attempt to keep pressure on China, though his diplomatic tools will shift away from tariffs and towards sanctions and multi-lateral pressure. A key priority of the Biden administration will be closer alignment with traditional allies through a commitment to free trade, rejoining the Paris Climate Accord and possibly negotiations for a new Iran nuclear deal. International markets may marginally benefit from this governmental configuration as the risk of U.S. tariffs or trade barriers eases.

Investment implications

Though a Democratic sweep makes for a less business friendly environment, we remain bullish on risk assets given unprecedented fiscal and monetary support. We expect greater regulation and likely higher taxes but the Democrats narrow Congressional majorities greatly limit the party’s latitude to implement some of the wider-reaching – and less market friendly – proposals in the Biden agenda. We expect a vigorous economic recovery aided by expansionary fiscal policy in the first half of the year and a reopening of the economy as COVID-19 vaccinations greatly reduce pandemic risk into the summer. This strengthening economy should lead to a big earnings boost for companies in 2021. Currently in portfolios we are reflecting these views through overweights in U.S. large cap equities, emerging market equities and U.S. investment grade corporate bonds.

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