Welcome to Thoughts on the Market.
I'm Ariana Salvatore, head of public policy research for Morgan Stanley.
And I'm Seth Carpenter, the firm's global chief economist and head of macro research.
Today we're discussing the run-up to the midterm elections and what it could mean for the macro outlook and policy response.
It's Wednesday, April 29th at 10 a.m. in New York.
Last week, Mike Zesus and I talked through the midterm elections and their potential consequences for the economy and markets.
This week.
We figured it might be helpful to talk about the setup into November, especially as we're both increasingly being asked about the macro outlook and potential for targeted stimulus to offset the oil shock.
So, Seth, let's start there.
We know cost of living is a key issue in elections and we've seen a pretty meaningful oil shock feed through markets.
How are you thinking about that in the context of the broader economy?
Our US economics team has estimated that the higher gas prices that we have now likely to have for the rest of the year are going to be more than enough to offset any boost to consumer spending from the higher tax refunds this year.
So I think that's the first point.
If you're expecting a boost to come through that channel, you probably want to unwind that.
And in fact overall, what we've done is lowered our forecast for US growth by about three or four tenths of percentage point worth of growth for this year because of the higher energy prices.
So it's a drag on spending, I think, no matter how you cut it.
And that's not happening in isolation, right?
No, that's exactly right.
That's exactly right.
We've also got at least somewhat restrictive monetary policy layered on top.
So financial conditions are already a little bit tight and the oil price shock sort of amplifies that tightening by weighing on spending.
That's going to be really important.
I think an extra complication then is what does it do to inflation?
For now, we don't think it's going to be that big of a deal.
History says, at least looking at the data, that when energy prices go up, when oil prices go up, gasoline prices go up, it does boost headline inflation for sure.
But the pass-through to core inflation is pretty limited and the effects tend to go away on their own without too much time.
So I think the real hit here is going to be from the higher-costs acting like a drag on consumer spending.
Right.
And importantly, it's a very visible shock.
Gasoline prices feed directly into how consumers and voters perceive the economy, which brings us into the political overlay as we approach the midterms.
Yeah, no, I think that's exactly right.
Whenever we economists are thinking about inflation and prices and consumers, We think about exactly that, what we call salience.
Just how visible are these prices?
And gasoline prices tend to be some of those prices that stick out in people's minds.
So people are seeing it and people are reacting to it.
Give me some idea of what the Congress can realistically do between now and the midterm elections.
Well, I would say, in theory, there's a range of options direct stimulus, targeted transfers.
We tend to frame affordability policies across five vectors energy, health care housing, consumer credit and trade policy.
But in practice, the constraints are pretty binding right now.
And, as we've been saying, tariff policy is really the only lever the president can pull easily to have a real impact on voters.
All right.
So you said constraints and constraints for the Congress.
Can you walk us through what those constraints are?
Sure.
So the first and most obvious is deficits.
We're already running large fiscal deficits in the US and I would say there's limited political appetite to expand them meaningfully from here in the near term, especially heading into an election.
The second is procedure.
If you want to pass something sizable, You're either looking at reconciliation, which requires political alignment and a number of procedural hurdles, or bipartisan cooperation to get around the filibuster.
Both seem difficult to us in this environment.
So my experience in Washington for a couple decades of work on policy is that when things are difficult They tend to take more time.
So how does the timing component of all this matter and how does it fit into the way that you're thinking about it?
Timing is the third constraint, the legislative calendar in particular.
What we see is, as you get closer to midterms really any election the window for passing major legislation narrows pretty quickly.
That's because lawmakers shift their focus toward campaigning and the agenda itself just becomes more limited.
And then to finish off the constraints, the fourth I would say is implementation.
Even if something were to pass, there's a lag between legislation and the actual economic impact.
Getting funds out the door, whether it's checks or programmatic spending, tends to take time.
Yeah, even well-targeted policy might not hit the economy in time to have the desired effect before the election.
Would you agree with that?
Yeah, but for argument's sake let's say we're wrong on that and Congress does manage to pass something.
Maybe not a broad-based stimulus package, but let's say some form of targeted relief.
From a macro perspective, what do you think would matter most?
Is it the size of the package, how quickly it gets implemented or which consumers are targeted?
Yeah, I'm going to have to say a little bit of all of the above.
I mean economic analysis really tends to show that tax cuts tend to simulate less than increased spending and transfers matter.
But it matters to whom those transfers happen.
So I do think if we're aiming at the lower end of the income, distribution probably has a higher propensity to spend.
And so you're more likely to see more of those dollars getting spent, and faster, if that's where it's going.
The size of the package has to matter as well, because more money out probably means more money getting spent.
But I will add there are two caveats this time around that we probably need to take into consideration.
First, with the increase in tax refunds that we've seen this year, surveys suggest that households are using that money to pay down outstanding debt more than they would have historically.
And so we might be in a situation, because of the past couple of years of affordability issues, where households are going to try to get ahead of things and pay down some of that debt.
And as a result, maybe there's a more muted effect on spending.
And second, we are living in a world right now where inflation is well above the Fed's target.
So if the extra stimulus leads to extra spending at a time when prices are already high, well there's a chance we might give an extra boost to inflation, And then the Fed would have to reconsider what it's doing on monetary policy.
But you said Congress is probably constrained.
So let's shift then and ask is there something that the president could do unilaterally with executive authority?
And in particular, sometimes I get this question from clients.
Even if there's not clear, well-defined legal authority...
We've seen something like that before with the tariff policy under the AIPA authority.
It was imposed and then later it was pulled back when it was judged by courts not to be the right authority.
So why wouldn't we think the argument goes, why wouldn't we think that some sort of large scale, maybe rebates or direct payments could get deployed quickly, even if the, let's say, legal authority is a little bit murky?
Yes, it's an interesting question, but I think there are a few important distinctions that make something like the administration sending out checks, for example, very different from tariff policy.
First, fiscal transfers are much more clearly tied to congressional authority, legally speaking.
Spending power, as you know, resides in Congress, and that's a pretty firm constitutional boundary.
And importantly, even something like tax refunds, which can look like direct payments, aren't discretionary.
They're preauthorized in the tax code and Treasury is just returning overpayments under a standing appropriation.
So there isn't really a comparable mechanism the administration could use to send out broad-based checks, for example, without new legislation.
Now, trade authorities, by contrast, have historically allowed for more executive flexibility, even if contested, like we saw with the AIPA tariffs.
Direct fiscal outlays are different.
You generally need explicit appropriation.
And then second, there's the operational side to all of this.
Even if you were to set aside the legal questions, there isn't a standing mechanism for distributing very large sums of money quickly without legislative backing.
Fair enough.
And if we stay in this totally hypothetical world, what would you imagine would be the timing of any legal challenges, if they did happen?
In a scenario like this, you'd likely see challenges fairly quickly and courts could intervene early in the process, potentially before funds are even fully dispersed.
So, Seth.
The idea that you could deploy something on a massive scale and only deal with the legal consequences much later is all the more uncertain.
But Seth, let's stay with the upside risk scenario for a moment.
If Congress did pass something targeted instead, where would you expect policymakers to focus?
Can we talk through maybe energy rebates, child tax credits, SNAP or nutrition support?
Or do you think something else aimed at the most rate, sensitive or cost of living sensitive households might make more sense?
Yeah, I think you've laid out there a pretty rational strategy for trying to Make things targeted for the people who are going to be feeling this affordability crunch the most.
And so the SNAP benefits, like you said, are nutrition support.
That's lower income households, families with children, people who really are living paycheck to paycheck and noticing these higher prices.
Energy subsidies or some sort of tax rebate, again trying to target where the pain is most acute the higher electricity prices, the higher gasoline prices.
That people are noticing, that people are feeling.
I think all of that seems very plausible.
I just want to flag though, that there is this possible hidden effect, which is, the more these policies mask the higher cost, the economic pain from the higher energy prices, the more it allows people to keep spending despite the higher prices.
And that spending with higher prices, well, that could easily lead to a tick up in inflation.
That could lead to a change in the Fed's reaction function and If it was strong enough, if growth picked up enough and inflation picked up, from here you could easily see the Fed hiking rates instead of cutting.
So, in other words, even if the policy surprise is maybe good news for consumers in the near term, markets would still need to think through whether it extends the inflation problem or changes the expected rate path.
I think that is exactly right.
I think this is very much a case where good news could be good news, but there are going to be lots of details and a macro backdrop because of inflation that's probably already under some pressure.
Which means the key drivers heading into the midterms later this year are likely to remain the ones that are already in place.
Energy prices, monetary policy and underlying growth dynamics, rather than potential new fiscal stimulus.
And so that means for markets, focus needs to stay on the fundamentals.
Exactly.
Elections can shape the policy path at the margin, but the macro cycle is doing most of the heavy lifting here.
And we think that's the case following the midterms as well.
If you'd like more detail there, please go ahead and listen to our podcast from last week on this topic.
Seth, thanks for taking the time to talk.
Arianna, thank you for inviting me.
And for the listeners, thank you for listening.
If you enjoy thoughts on the market, please share it with a friend or colleague today and leave a review wherever you listen to podcasts.
The preceding content is informational only and based on information available when created.
It is not an offer or solicitation, nor is it tax or legal advice.
It does not consider your financial circumstances and objectives and may not be suitable for you.
