Takahide Kiuchi’s View - Insight into Economic Trends: U.S. Economic Policy After the Midterm Elections, and a Turning Point in the Foreign Exchange Market
Nov. 11, 2022
The 2022 U.S. midterm elections were held on November 8, but it will take some time before the final results are confirmed. Neither candidate in the Georgia Senate race has won a clear majority of the votes, and so it will go to a runoff on December 6. The Democratic and Republican Parties are now struggling for control of the U.S. Senate as a whole. Meanwhile, although the ruling Democratic Party fared surprisingly better than the latest predictions suggested it would in the House of Representatives race, it now appears that the Democrats will lose their majority in the House by a slim margin to the Republicans.
Attention is turning quickly to the 2024 U.S. Presidential Election
If the Democratic Party loses its majority in the House of Representatives and the House “flips”, the Biden Administration will inevitably face even greater difficulties with governing in its remaining two years.
This midterm election has the distinct impression of a referendum on the policy conduct of the Biden Administration’s first term. Amid strong headwinds created by record-high inflation, the Biden Administration’s appeal to save democracy and protect abortion rights does seem to have reached voters to some degree. However, President Biden’s approval rating remains low, and given his age and health concerns, it’s possible that more Democratic voters will choose not to support the president if he should run again in the 2024 election.
There have also been some U.S. presidents who chose not to seek a second term because of opposition within their own party. For example, in March 1968, Democratic President Lyndon Johnson—pressed by the anti-Vietnam War faction of his party—announced suddenly that he would not be running for reelection in the fall of that year. All eyes will thus be focused on what course of action President Biden decides to take.
On the other hand, this midterm election cycle has in some sense provided a chance to gauge the popularity of Republican former President Trump, and it has become something of a prelude to the 2024 Presidential Election. Former President Trump has insisted that the victories won by many Republican Congresspeople and Governors whom he personally supported are proof of his influence and clout, and he might officially announce his intention to run in the next Presidential election sometime soon.
The midterm elections may have only just ended, but people’s attention is rapidly shifting toward the 2024 election.
Could there be major changes to diplomatic and security policies?
Even if the House were to flip, that probably wouldn’t lead to any major changes in the Biden Administration’s diplomatic and security policies. A major characteristic of the Biden Administration’s policy stance in this field has been its policy toward China in partnership with U.S. allies. Even if the Republicans gain a stronger position in Congress, the Republican and Democratic Parties both take a hardline approach to China, and so it seems the current U.S. policy regarding China would easily be maintained. As a result, there will likely be no great change to Japan’s stance of confronting the Chinese military threat together with the U.S. and its other allies and pursuing economic security policies with China in mind. We may also suppose that the U.S. policy toward North Korea will remain deadlocked after the midterms.
On the other hand, what could perhaps change is the U.S. response to the war in Ukraine. There are some within the Republican Party who are critical of the Biden Administration’s extension of military aid to Ukraine with no sign yet of when the war will end. The Biden Administration might well face Republican demands to change course in its Ukraine policy from offering military aid to instead seeking a ceasefire agreement.
Economic policies intended to win over independents
The Biden Administration’s economic policies aren’t likely to be heavily influenced right away by the results of the midterms. The American people’s concerns over the government’s handling of record-high inflation will continue to be a top-priority issue.
Yet the Biden Administration might conceivably begin focusing more on winning over independents going forward in the leadup to the next Presidential election. In that case, it could slightly shift its economic policies—which so far have leaned heavily leftward—toward a more centrist approach. More specifically, this would mean a style of policy management that also gives some consideration to corporations and the wealthy.
Given the foregoing, I believe we ought to pay more attention to the possibility that the Biden Administration will revise its foreign exchange policy. That could have an extremely significant impact on the global economy and the financial markets. Thus far the Biden Administration has been strongly inclined to tolerate the strong U.S. dollar with expectations that it will curb high prices, but if it becomes clear going forward that the dollar’s appreciation is hurting the ability of U.S. exporters to compete internationally, the administration might start to show an intention to restrain the excessively strong dollar.
However, the FRB (Federal Reserve Board)’s stance on major policy interest rate hikes—which lies behind the dollar’s appreciation—isn’t likely to change immediately, and so it’s possible that the Biden Administration and the FRB may temporarily be at odds over financial policy and foreign exchange policy.
Rate hike at the December FOMC could be only 0.5%
At the November 2nd FOMC (Federal Open Market Committee), the FRB decided to raise interest rates by 0.75%, consistent with prior expectations in the financial markets. This marked the fourth consecutive session at which a major rate hike of 0.75% was implemented, and it put the policy interest rate range at 3.75% to 4.0%. This is the highest level seen in around 14 and a half years since January 2008.
The statement made at this FOMC meeting included some new language: “In determining the pace of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.” This phrasing would seem to suggest the possibility that the pace of these rate hikes may be reduced down the road.
The FRB has started to become acutely aware of the risk of “overkill”, which is what would happen if the rate hikes were to go too far and ultimately cause economic conditions to seriously deteriorate. There’s arguably a greater chance now that the scale of the rate hike could be lessened to just 0.5% at the next FOMC meeting in December.
Has the strong dollar/weak yen era reached its end?
In light of the statement made at this past FOMC meeting, one might say that the FRB’s rate hike phase has at last reached its final stage. The strong dollar/weak yen situation in the foreign exchange market—which has been significantly affected by the FRB’s rate hike stance—has perhaps also come to an end. Currently, the financial markets have already more or less factored in the 0.5% rate hike expected to be made at the December FOMC meeting. That said, the curtailment of the rate hike from 0.75% to 0.5% at the December session had been anticipated by the financial markets since prior to this past FOMC meeting. The “magic number” for rate hikes, meaning the kind of turning point that would be enough to significantly alter the trend of global financial markets, is not 0.5% but rather 0.25%. Once the financial markets get a strong sense that the FRB may shrink the range of its rate hike to 0.25%, the upward trend in long-term interest rates may well come to a halt, with the strong dollar/weak yen scenario also having run its course.
Furthermore, if the Biden Administration does revise its stance of tolerating the dollar’s appreciation as I discussed earlier, and this revision coincides with a change in the FRB’s rate hike approach, then not only will the strong dollar/weak yen situation come to an end, but we could even see a major unwinding toward a weak dollar/strong yen scenario.
While there remains much uncertainty about what lies ahead, one might hazard to guess that the timing of this turning point will be somewhere between the December FOMC meeting and the period from January to March of next year. In that event, we could see a substantial turnaround from the strong dollar/weak yen to a weak dollar/strong yen situation before the exchange rate reaches 160 yen per dollar.