The current expectation for legislative stalemate could be completely upended by a significant economic downturn. A recession would make fiscal stimulus more politically appealing to both parties, consistent with historical patterns, creating an environment for policy action that otherwise seems unlikely given the political landscape.
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A rapid, significant (e.g., 5%) spike in unemployment over a short period (e.g., 6 months) due to AI would trigger an immediate and massive political and economic response. This would be comparable in speed and scale to the multi-trillion dollar stimulus packages passed during the COVID-19 pandemic.
Political gridlock is portrayed as an intentional strategy. By creating a temporary economic downturn via a shutdown, the administration creates fiscal and monetary space to inject massive stimulus leading into midterm elections, timing the recovery for political gain.
Regardless of the national deficit, expect more fiscal stimulus as politicians prioritize winning elections. The need to address voter concerns about 'affordability' ahead of midterms will drive spending, creating a 'run it hot' environment favorable to hard assets.
Political deadlines like military pay dates are often overcome. The true forcing mechanism for ending a prolonged government shutdown is the breakdown of essential services that cause widespread public pain, such as air traffic control disruptions or the cessation of welfare benefits like WIC and SNAP.
Current equity market strength relies on a favorable policy mix. However, an underlying risk is the lack of any political path to address elevated U.S. deficits. This places the entire burden on continued economic growth to manage fiscal issues. If growth falters, these deficit concerns could emerge as a major risk factor.
The traditional relationship where economic performance dictated political outcomes has flipped. Now, political priorities like tariff policies, reshoring, and populist movements are the primary drivers of economic trends, creating a more unpredictable environment for investors.
Even if Democrats win the House, their majority would likely be too slim to significantly change policies that impact market pricing. Similarly, a plausible Republican agenda like more tax cuts would face internal party opposition from fiscal hawks, suggesting a continuation of policy gridlock regardless of the outcome.
The Federal Reserve is pressured to cut rates not just for economic stability, but to protect its own independence. Failing to act pre-emptively could lead to a recession, for which the Fed would be blamed. This would invite intense political pressure and calls for executive oversight, making rate cuts a defensive institutional maneuver.
The current administration's singular focus on AI has exacerbated a K-shaped recovery, hurting the average voter. To win re-election, politicians will be forced to stimulate other sectors of the economy to lift "Main Street" out of recession, making the concentrated AI/Meg7 trade less attractive moving forward.
The current administration is tolerating economic pain and a market slowdown now, a year before midterm elections. This creates the political capital and justification to aggressively stimulate the economy and boost markets right before voters head to the polls.
