WASHINGTON, Aug 2 (Reuters) - With U.S. congressional elections approaching, the actions of legislators and the administration will be watched closely by investors in the coming months. Here are the main political risks to watch in the United States.
Republicans are likely to gain ground when all 435 seats in the House of Representatives and 37 of the 100 seats in the Senate come up for grabs in the Nov. 2 midterm elections.
The high jobless rate is dragging on the Democrats’ poll ratings and Republicans might win control of the House and probably pick up seats in the Senate. [ID:nN2947678]
That would make it difficult for Obama to win the kind of legislative successes he had in his first two years in office.
What to watch:
-- Obama will probably have to deal with resurgent Republicans in Congress. The question is whether he will be able to work with them to slash the budget deficit and boost job hiring or whether politicians will be stuck in gridlock while the economy languishes. An early and crucial test of this will come in December when a bipartisan commission makes recommendations on how to cut the deficit.
-- Republican electoral gains are likely to be welcomed by financial markets keen to dampen Obama’s zeal for regulating business, like healthcare reform and the crackdown on Wall Street. While there are always other factors such as company earnings to push shares, historically the S&P 500 index does well in the year after midterm elections regardless of the result partly because the third year of a presidential term is seen as a stable period politically. The last time the Republicans did well in a midterm vote under a Democratic president was in 1994. Stocks rose 25 percent in the 12 months from October that year.
-- Republicans have threatened to repeal Obama’s healthcare and financial regulation laws but that is improbable as they would need a two-thirds majority in both the House and Senate. Legal challenges to healthcare reform by states could win more traction.
Deficit projections have soared to $1.47 trillion and public debt is at $13 trillion. The Republicans doing well in the election is seen as positive for deficit reduction. No one party then has to take the blame for tough cuts.
What to watch:
-- Despite the hefty debt burden, the U.S. Treasury has had no difficulty so far finding willing buyers of government bonds, and interest rates remain very low. The concern is that buyers may one day lose faith in politicians’ willingness to put finances back on a sustainable path. They might refuse to cheaply finance U.S. spending, and borrowing costs would spike. That could also make it more expensive for companies and consumers to borrow, slowing the economy. In an unlikely doomsday scenario, the United States would have so much difficulty attracting debt investors that it would be forced into taking stern measures to curb spending and raise taxes. One worry would be that the Federal Reserve might begin printing money to buy Treasury debt, which could devalue the dollar and drive up inflation. Political gridlock is often welcomed by markets when an economy is doing well but Wall Street would punish failure to reach agreement on the deficit.
-- A bipartisan commission will make recommendations by December on how to reduce the deficit. A leading Democrat on the panel has suggested a cap on government spending, putting him more in line with Republican thinking and increasing the chances of the commission producing feasible ideas.
-- In the end, implementation of the commission’s ideas by Congress in 2011 is everything and bipartisan cooperation will be needed. Republicans will push for spending cuts while Democrats are expected to seek tax increases.
-- Austerity measures. While markets are keen on keeping the deficit under control, an austerity program that crimps consumer spending could hit company earnings or stunt economic growth.
-- New White House budget director Jack Lew, a Clinton administration veteran who is trusted by markets and Republicans. He will set the tone for deficit reduction.
BUSH-ERA TAX CUTS
The U.S. Congress is likely to vote by the end of the year on whether to extend tax cuts dating back to George W. Bush’s presidency. Letting the cuts expire would help plug a hole in the deficit but would be unpopular with voters.
What to watch:
-- A tax on company dividends for upper income groups that will shoot up to 40 percent from 15 percent now if lawmakers do not extend the cuts. Capital gains taxes would also rise from 15 to 20 percent.
Disruption to the United States’s complex relations with China can move bonds, currencies, stocks and commodities globally. Beijing is the biggest single holder of U.S. Treasuries with around $900 billion of them and some in Washington have long feared that China could dump the bonds because of a serious political dispute, say over Taiwan, bringing prices tumbling down. But that would be counterproductive to China and is seen as unlikely.
What to watch:
-- Senators led by Democrat Charles Schumer might press ahead with a bill to punish Beijing by charging duties on exports to the United States if it does not revalue the yuan. A big one for forex and bonds. U.S. companies with most to benefit from a stronger yuan include Caterpillar CAT.N, Alcoa AA.N and General Electric GE.N but they also stand to lose from any tit-for-tat trade fight with Beijing. A yuan revaluation might stimulate Chinese demands for commodities but that could be offset by reduced export competitiveness.
-- Taiwan lingers as a potential flashpoint in China’s relations with Washington but trade ties between the island and Beijing have improved. A more likely diplomatic dispute would be a sudden incident like China confronting U.S. surveillance ships in waters off China’s coast.
-- A larger Republican presence in the U.S. Congress after the midterm elections could pressure Obama to be tougher on Beijing on Taiwan and the yuan.
-- Friction between multinationals and the Chinese government after Google GOOG.O and Beijing locked horns over the Internet giant's search page. That dispute has been fixed but companies like GE, Siemens SIEGn.DE and BASF BASF.DE, have also complained of the tough investment climate in China.
OIL SPILL AND ENERGY LEGISLATION
The Obama administration and Democrats in Congress want to clamp down on the oil industry's offshore drilling practices after the massive Gulf of Mexico spill. There is a ban on deepwater drilling in the Gulf as well as investigations into companies involved in the blown-out well owned by BP Plc BP.LBP.N and major energy legislation in Congress.
What to watch:
-- The House of Representatives last week passed legislation to reform offshore drilling in a bill that Republicans warn will slash U.S. oil and gas production in the Gulf. But the measure still has a long way to go before it can become law because it would have to be merged with a similar bill pending in the Senate. That chamber begins its summer recess on Aug. 6. A sticking point in the Senate is an effort to remove all liability limits oil companies would face for economic damages stemming from oil spills. Current law requires companies to only cover up to $75 million for damages to local economies. The entire oil industry will watch closely.
-- Congress might approve clean energy initiatives, such as energy efficiency programs and incentives for heavy trucks to run on natural gas. Alternative energy companies like First Solar FSLR.O, SunPower Corp SPWRA.O, Germany's Solarworld SWVG.DE and China's Suntech Power STP.N are likely to benefit as are General Electric Co and Siemens Corp SI.N which makes electronics and does engineering for low-carbon energy sources.
-- Lawmakers have shied away from plans for sweeping climate change legislation that would have put a price on carbon emissions blamed for global warming but the issue might resurface later in the year. That could affect electric utilities, oil companies, natural gas producers and users such as chemical companies and the auto industry. One suggestion for a future climate change bill is to include a cap for electric utility companies on emissions of carbon. That could hit shares in American Electric Power AEP.N, the largest coal consumer in the country, as well as Duke Energy DUK.N and Southern Co. SO.N.
-- Legal wrangling over Obama’s suspension of deepwater drilling. A moratorium in May barred new drilling below 500 feet for six months, but it was put on hold by a judge. The Interior Department has issued a new moratorium which has also been challenged in court. It could be several months before the drilling ban is lifted, either by a court, Congress or because the government is satisfied drillers can prevent a blowout and respond adequately to any new disaster. Expect oil companies’ shares to rise when the ban is scrapped. The moratorium has had little effect on the price of oil so far.
-- The Justice Department has launched a criminal and civil investigation into the spill, but officials have not identified the targets. The likely companies that will be the focus of the investigation include BP, Transocean Ltd RIGN.S, Cameron International CAM.N, and Halliburton Co HAL.N. BP says it expects fines and one estimate, by Barclays Capital, puts possible penalties for the company at up to $27 billion. (Additional reporting by Rick Cowan, Paul Eckert, Emily Kaiser, Matthew Daily and Tim Gardner; Editing by Howard Goller)
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