January 16, 2018

Trump 2018: What’s Next?

After a turbulent first year dogged by investigations, staff turmoil and low approval ratings, President Trump is heading into 2018 with some momentum. He has managed to pass significant tax cuts, nominate many conservative judges, and reduce regulations, which has been particularly lauded by small-to-medium sized businesses. All of this, his supporters claim, has helped to strengthen the economic recovery and drive stock market valuations to record levels. The Trump administration will look to build upon this momentum in 2018.

Trump's greatest opportunities include: continuing to advance his deregulation agenda, which quite often does not require congressional approval; and passing legislation to modernize the nation’s infrastructure, one the few areas with the potential for bipartisan support. Success on either of these two fronts could give animal spirts a further boost.

However, Trump also has more than his share of major challenges. One of the most prominent being mid-term congressional elections scheduled for November 2018. Losing control of at least one chamber of Congress would not only stop Trump from advancing his legislative agenda, it would also increase the risk of Democrats beginning impeachment proceedings against him. Trump’s relatively low approval ratings has heightened the risk of an electoral setback.

NAFTA negotiations are another challenge. Trump’s main goal is to extract enough concessions from Mexico and Canada to declare victory without overly disrupting the U.S. economy and alienating his electoral base. Despite the fears surrounding these talks, we still feel a negotiated solution is likely for reasons explained in our recent report: “Update on NAFTA Negotiations, December 18, 2017).

Trump’s below-the-radar war on regulations

While headlines focus on alleged collusion with Russia and Trump’s tweets, his administration is making significant headway on the regulatory front. To push his deregulation agenda forward, President Trump has in many cases nominated people from the private sector to lead the very regulatory agencies they spent years opposing. For example:

EPA Administrator Scott Pruitt built his political career on suing the agency. David Zatezalo, a former mining executive, is now in charge of safety in the mining sector. Rebeckah Adcock, a former chemical industry representative, is in charge of writing chemical safety rules. Jospeh Otting, a former banker, is in charge of the Office of the Comptroller of the Currency.1

What makes regulatory reform a particularly juicy target is that changes can often be made without congressional approval. For instance, passing legislation to repeal or amend the Dodd-Frank Wall Street Reform and Consumer Protection Act is nearly impossible. Although Republicans hold a majority in both the House and the Senate, they fall short of the 60 votes needed to break a filibuster in the Senate. But making regulatory changes to Dodd-Frank does not require congressional approval. Indeed, senior policymakers at the Federal Reserve, the Office of the Comptroller of the Currency, the SEC and the Federal Deposit Insurance Corporation all have significant powers to shape and change the regulations guiding Dodd-Frank.

As for regulations -- particularly in the energy sector -- that must undergo a long review process before they can be officially amended (i.e. carbon emissions from coal-based power plants), the simple act of not vigorously enforcing existing rules is having a significant impact. For example, in the first 266 days of the Trump administration, the Environmental Protection Agency (EPA) filed about a thousand fewer cases and handed out $9 billion less in fines compared with the same period of the Obama administration. Not surprisingly, this reduction in legal action has been lauded by much of the energy sector and criticized by environmentalists.

                                                            1 “Ex-Industry Lobbyists Win Top Jobs in Agencies They Once Fought,” Bloomberg, December 21, 2017

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EPA enforcement across the past three administrations

Source: “Under Trump, E.P.A. Has Slowed Actions against Polluters, and Put Limits on Enforcement Officers,” New York Times, December 10, 2017

Further, Trump has approved several long-delayed oil pipelines, opened vast swaths of Alaskan wilderness to new oil and gas drilling and intends to permit greater offshore energy exploration.

The President has also overseen a historic slowdown in rule-writing by federal agencies. Since he came to power, the enactment of new rules has slowed by about 60%.

Source: “How to judge whether deregulation is going too far,” The Economist, October 12, 2017

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The Trump administration has slowed the pace of new rules by ordering agencies not to impose any new regulatory costs on companies. He also mandated that agencies eliminate two regulations for each new one created.

Small-and-medium-sized businesses have been particularly supportive of reducing regulations

Unlike their much larger corporate counterparts, they generally do not have the financial resources to hire armies of compliance specialists to interpret regulations. The small-business optimism index from the National Federation of Independent Businesses (NFIB) came in at all time of 104.9 in December. The NFIB has officially attributed this enthusiasm to tax cuts and regulatory relief.

The courts also could play vital role in advancing Trump’s regulatory agenda

In addition to nominating Neil M. Gorsuch to the Supreme Court, the Senate has confirmed 12 circuit court judges and eight appellate judges. This is the highest number of circuit court picks confirmed in a president's first year in office. There is currently 47 judicial nominees awaiting Senate approval.2 The more there are conservative-leaning judges on the bench, the greater the odds that Republican laws and regulations will successfully withstand legal challenges.

Will Trump try to pass an infrastructure bill before the midterm elections? President Trump is strongly in favour of getting an infrastructure bill passed. Trump’s plan is to have the federal government spend about $200 billion on infrastructure projects over the next decade. The funds would be largely dedicated to public-private joint projects in the hope it could spur some $1 trillion in overall investment. The Trump administration is also seeking ways to shorten the lengthy approval process for infrastructure projects. However, getting Congress to pass such legislation faces several challenges:

Projections that the debt will increase by $1 trillion over the next decade owing to the recently enacted tax cuts will make an infrastructure bill a harder sell for Republicans politically. The intention to offset the cost with cuts elsewhere in the federal budget is easier said than done, especially in an election year.

The White House will need the support of Senate Democrats to get this bill approved. While there is strong support among Democrats to repair the nation’s infrastructure, Trump’s plan faces two major barriers. First, the Democrats want most projects to be directly funded by the government, as opposed to incentivizing private sector participation. Second, they may be reluctant to help Trump and the GOP score a victory so close to the 2018 midterm elections.

Trump’s hope is to convince the 10 or so Senate Democrats in red states to support the plan. Should Trump’s approval ratings remain strong in their states, this could force some of them to support a modest infrastructure bill to avoid a voter backlash. A compromise could entail half the sum being spent directly on infrastructure and the other half going towards incentivizing private sector involvement.

The two-year window to pass legislation Presidents have historically had the most success implementing their legislative agenda in the first two years of their mandate (i.e., before midterm elections). After that, the odds of signing major bills into law tend to drop significantly. President Obama is a perfect case in point. In the first 18 months of his first mandate, he passed the American Recovery and Reinvestment Act, Obamacare and Dodd–Frank. He then lost control of Congress and was forced to rely on executive orders to advance the rest of his agenda. The reason for this is that, in the past two decades, whenever a major bill got passed, it tended to have the support of only one party. The most recent example is the Republican tax bill, which did not receive a single Democratic vote.

Source: “Why Competition in the Politics Industry is Failing America,” Harvard Business School, September 2017

                                                            2 “What has actually changed under Trump?,” BBC, January 12, 2018

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2018 midterm congressional elections The Democrats are hoping that the public will perceive the recent Republican tax cuts as mostly benefitting the wealthy and big business and that this will lead to major electoral gains in the upcoming elections. In this regard, they are looking to take a page from the Republican playbook. In 2010, the Republicans profited from the backlash against the Affordable Care Act to regain control of the House.

For their part, the Republicans are hoping that a strong U.S. economy, soaring stock markets and workers seeing greater take-home pay in 2018 thanks to their tax cuts will pay off at the polls. While the tax bill’s does benefit the wealthy and large corporations, the non-partisan Tax Policy Center estimates that 80% of taxpayers will get a tax cut averaging about $2,100 in 2018.3

A recent poll by Quinnipiac found that 66% of American voters say the economy is "excellent" or good", the highest rating for the economy in the survey's two-decade history. But 49% say former President Obama deserves the credit, while only 40% say Trump does. Republicans hope that as time passes more people will give Trump credit for the economy’s strong performance.

Historically, the party in power loses seats

The Republicans are also facing strong historical headwinds. The party in power has lost House seats in 9 of the last 10 congressional elections held at the midpoint of a president’s first term. As for the Senate, the odds are better. The sitting president’s party has only given up seats in 6 of those 10 elections.4 Historically, supporters of the party not in power have tended to be more motivated to show up at the polls.

If we consider all the midterm elections in the post-war era, the president’s party has lost House seats 16 out of 18 times. The president’s party gained midterm seats only twice: in 1998 under Bill Clinton (66% approval) and in 2002 under George W. Bush (63% approval).5

The fact that Trump has the lowest approval rating of any modern president at this point in his tenure has heightened fears that Republicans will suffer heavy losses. Trump’s approval in a Gallup poll was 35% at the end of 2017. By comparison, Obama (2009) and Clinton (1993) ended their first year in power with approval ratings of 50% and 54%, respectively. This support, however, did not prevent them from doing very badly in their first midterm elections.6

Source: “Democrats’ prospects in the 2018 midterm elections, explained,” Vox, November 8, 2017

                                                            3 “Democrats look to capitalize on unpopular tax reform,” Financial Times, December 20, 2017 4 “Here's why the 2018 Senate election will be crucial,” Los Angeles Times, February 2017 5 “Democrats’ prospects in the 2018 midterm elections, explained,” Vox, November 8, 2017 6 “Keep Trump off the Trail in 2018,” Wall Street Journal, December 20, 2017  

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It is important to note that many presidents who suffered major setbacks in midterm elections went on to be re-elected. Further, in the era of Trump and Brexit, nothing should be taken for granted. As the following chart shows, Trump’s favourability rating was very low also just before he won the presidential election last November.

What would it take for Republicans to lose control of Congress?

Republicans currently hold a comfortable majority in the House of Representatives (241 to 194). In order for the Democrats to seize control of the House, they would have to gain 24 seats. Their greatest hope for gains lies in the 23 Republican-controlled districts won by Hillary Clinton in the last presidential election.

However, the Republicans do enjoy some important structural advantages. Their control of the House has been strengthened by two factors: 1) Democrats’ tendency to win with overwhelming margins in heavily Democratic urban areas, thus wasting votes; and 2) gerrymandering, which is the process of redrawing the boundaries of legislative districts to favour one’s party. This is done essentially by moving likely non-supporters to other electoral districts lost in advance. In order to overcome these barriers, Democrats would have to win the congressional popular vote by at least 8% to 10% to have a chance of regaining control of the House of Representatives. As the following chart illustrates, they are currently just above this threshold in the polls.

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As for the Senate, the Republicans’ margin of control is much slimmer (51 to 49, if we include the two independents that often vote with the Democrats). However, the Democrats will be defending 25 seats, compared with just eight for the Republicans. The situation has been made even more challenging for the Democrats by the fact that 10 of their seats up for re-election are in states Trump won. In contrast, only one Republican seat is at stake in a state that Clinton won (Nevada).

In all, 435 seats in the House of Representatives and 34 of the 100 seats in the Senate will be contested in November 2018.

The loss of one or both chambers of Congress would constitute a major setback for President Trump and the Republicans for the following reasons:

The GOP would not be able to pass any more major bills with just Republican support.

Regardless of whether Muller has completed his investigation, it would increase the risk of Democrats beginning impeachment proceedings against Trump (more on this later).

Republican loss of Senate control would give Democrats veto power over Trump to nominate judges and heads of regulatory agencies. Trump needs a majority of votes in the Senate to confirm nominees.

The midterms also hugely important for redistricting

Most state governorships are also up for re-election in November 2018. The winners will be in a position to reshape the electoral districts of their state during the 2020 national census, an exercise conducted every ten years. During the last census, Republican governors were able to shape federal districts in a manner that greatly benefitted the Republicans in the 2010 mid-term congressional elections. Michigan is but one example of how effective gerrymandering can be. Last fall, voters statewide split their ballots essentially 50-50 between Republican and Democrat House candidates. Yet, Republicans won 57% of the federal house seats.7

A potential game changer is the first ever ruling by a panel of state federal judges that districts gerrymandered by the Republicans in North Carolina are illegal. The Republican Party intends to appeal the decision to the Supreme Court and request that the matter be frozen until the appeal is heard. A negative ruling would cost Republicans seats in North Carolina, and set a legal precedent for other states. The Republicans are somewhat comforted by the fact the majority of Supreme judges are conservative-leaning (5-4).

How difficult is it to impeach a president?

The process of removing a president from office for an alleged criminal offence begins in the House of Representatives. If a simple majority (50+1) votes to begin impeachment proceedings, the matter proceeds to the Senate, where a two-third majority (67 votes) is then required to actually remove a president from office. Impeachment has been attempted only three times in U.S. history:

In 1868, the House voted to impeach Andrew Johnson for firing the Secretary of War. The Senate fell just one vote short of the two-third majority needed for the motion to pass.

In 1974, Richard Nixon resigned from the presidency when it became clear he would be impeached by the House and convicted by the Senate for crimes related to the Watergate scandal.

In 1998, the House voted to impeach Bill Clinton for attempting to cover up an affair with intern Monica Lewinsky, but the motion failed to muster sufficient votes in the Senate.

There is a risk, also, that the investigation will drift towards unrelated matters. In the 1990s, Kenneth Starr was appointed Independent Counsel to investigate then President Bill Clinton’s connections to a failed real estate investment deal. The probe ultimately led to impeachment proceedings against Clinton for lying under oath about his affair with an intern.

What stands in way of Trump’s impeachment?

Only the House of Representatives can begin an impeachment process, so even if Trump is judged to have broken the law, it would still be up to the Republican-controlled Congress to hold him to account. The majority party in Congress has never sought to remove from office a president elected from its own party.

The reluctance among many Republicans to move against Trump is reinforced by the fact that, while his approval rating is hovering in only the 38% to 40% range, the vast majority of Republican voters still support him. Attacking the President would

                                                            7 “AP analysis shows how gerrymandering benefited GOP in 2016,” Associated Press, June 25, 2017

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be electoral suicide, perhaps jeopardizing even normally safe Republican seats if Trump supporters were to abstain from going to the polls. However, this reluctance to turn against President Trump could begin to crumble if investigations revealed that Trump committed a major crime and/or if his popularity among the Republican base collapsed (see chart below).

Further, even if Democrats regained control of the House and began impeachment proceedings, they would still need the support of many Republicans to obtain the two-thirds majority vote required in the Senate to remove a president from office.

The partisan divide surrounding Mueller investigation

The Mueller investigation has only served to widen the partisan divide. The recent arrest of Michael Flynn, Trump’s former national security adviser, is a case in point. To Trump’s detractors, he has something very valuable to offer in exchange for a lenient plea deal. To Trump’s supporters, however, the charge against Flynn for making false statements is evidence that investigators are nowhere near to proving collusion with the Russians. The Republicans, for their part, accuse Clinton and the Democrats of breaking security protocols with regard to her use of a private email server and suspicious ties with Russians. Harvard Law Professor Alan M. Dershowitz has labelled this bitter divide “the criminalization of political differences”.

An anti-Trump civil service Another important under-reported hurdle facing the administration is the anti-Trump bent most of the federal civil service seems to have. For starters, only 4.1% of the electorate in Washington, DC, voted for Trump. Federal employees also overwhelmingly backed Clinton’s presidential campaign in terms of political donations (see chart below). This lack of support renders the Trump administration much more vulnerable than previous ones to bureaucratic resistance and leaks.

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Source: “Government workers shun Trump, give big money to Clinton,” The Hill, October 26, 2016

Conclusion In summary, the Trump administration faces the following challenges and opportunities in 2018:

Investors should spend more time focusing on who is leading key regulatory agencies and less time on bills, which often have a slim chance of becoming law. Unlike legislation, the heads of regulatory agencies can often implement changes without congressional approval. They can also choose not to rigorously enforce existing regulations or laws.

Despite bipartisan support for infrastructure projects, getting an infrastructure bill approved will be easier said than done. Trump’s hope is to convince the 10 or so Senate Democrats in red states to support the plan. Should Trump’s approval ratings remain strong in their states, this could force some of them to support a modest infrastructure bill to avoid a voter backlash.

Should polls continue to show Democrats leading Republicans by at least 10% in the upcoming congressional elections, Trump will likely lose control of at least one chamber of Congress. This would not only bring Trump’s legislative agenda to a skidding halt, it would also increase the odds of the Democrats beginning impeachment proceedings, whether Mueller has completed his investigation or not. While impeachment proceedings would most likely be unsuccessful, they would be a major distraction for the Trump administration.

Investors are advised to monitor Trump’s support among Republican voters and in the right-leaning media very closely. These are indicators of whether his administration will be able to withstand the political headwinds it faces. If Trump was to lose support of the right-leaning media, the chances of his electoral base and party abandoning him would increase dramatically.

Canadian corporations face increased U.S. competition. All things being equal and notwithstanding concerns over longer-term effects on the environment, the combined impact of lower taxes, the ability to amortize capital investments immediately and less regulation could place certain Canadian companies (particularly in the energy sector) at a competitive disadvantage. This will make it much harder for Canadian governments to continue pushing for higher regulations on business.

Angelo Katsoras

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Economics and Strategy

Montreal Office Toronto Office

514-879-2529 416-869-8598

Stéfane Marion Marc Pinsonneault Kyle Dahms Warren Lovely Chief Economist and Strategist Senior Economist Economist MD, Public Sector Research and Strategy stefane.marion@nbc.ca marc.pinsonneault@nbc.ca kyle.dahms@nbc.ca warren.lovely@nbc.ca

Paul-André Pinsonnault Matthieu Arseneau Jocelyn Paquet Senior Fixed Income Economist Senior Economist Economist paulandre.pinsonnault@nbc.ca matthieu.arseneau@nbc.ca jocelyn.paquet@nbc.ca

Krishen Rangasamy Angelo Katsoras Senior Economist Geopolitical Analyst krishen.rangasamy@nbc.ca angelo.katsoras@nbc.ca

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