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outlook

The United States is heading into a period of political gridlock that will complicate efforts both to mend the economy and lessen the country's fiscal troubles.

Opinion polls indicate that in Tuesday's midterm vote, the Republican party will seize control of the House of Representatives and possibly the Senate as well, ending two years of domination by Democrats.

The result, observers say, will be a weakened president, a resurgent conservative opposition, and legislative stalemate. To get anything through the Senate will require a modicum of bipartisan co-operation, something that is in exceedingly short supply in Washington.

In such an environment, tackling major policy issues like the yawning deficit and the fate of housing giants Fannie Mae and Freddie Mac will be difficult to impossible. Another round of stimulus spending would be politically unachievable, observers predict, as would a further extension of jobless benefits.

The new political calculus comes at a vulnerable moment for the U.S. economy. The recession is over but the recovery remains anemic and job creation is weak. The Federal Reserve is about to embark on a new round of unconventional measures to pump money into the economy in an attempt to improve its trajectory.

The next two years will feature "massive gridlock and little co-operation," wrote Brian Gardner of investment firm Keefe Bruyette & Woods in a recent report. "We do not expect significant progress on budget matters … and we think more pressure will be placed on the Fed as the lone governmental entity with the power to support a weak economy."

Some investors take a more benign view of the impending stalemate. Because it reduces the government's room to manoeuvre, there will be fewer policy changes for businesses and markets to absorb. Traditionally, the third year of a president's term has brought healthy gains for stocks, even if it's not a time of peak legislative accomplishments.

Others worry that the current circumstances are unusual enough that the old Wall Street adage - "gridlock is good" - won't hold. "In today's challenging environment, inaction is dangerous," analysts at Merrill Lynch wrote last week.

Taxes will be a flashpoint. Nearly all Republicans have sworn to oppose any tax increases. Democrats, meanwhile, will not support substantial cuts to federal spending unless higher tax revenues are also part of the mix. An early test will be the debate about whether to extend a series of Bush-era tax cuts set to expire at year's end.

Both parties will be manoeuvring with an eye fixed firmly on the presidential election of 2012. Republicans in particular are keen to avoid repeating their experience of the mid-1990s, when they took control of Congress halfway through then-president Bill Clinton's first term.

Brimming with deficit-cutting fervour, the Republicans shunned a potential compromise with Mr. Clinton, producing an impasse that led to the closing of the federal government for several weeks. In the end, the two sides reached an agreement, but voters blamed the Republicans for the shutdown, contributing to Mr. Clinton's re-election.

Ron Haskins, a fellow at the Brookings Institution, worked for a powerful House committee in the mid-1990s. He notes that the deal that was eventually brokered by the two parties and Mr. Clinton, together with robust economic growth, helped put the country on a path toward a budgetary surplus.

But Mr. Haskins isn't optimistic that will happen this time around. "I would say we will definitely repeat the first half of that history" - the confrontational part - "let's see if we get to the second part," he said.

"There will be lots of fights and lots of sound and fury and lots of stalemates," he predicted. Later, opinion polls "will show the public is totally disgusted and at that point both sides will have to come to their senses."

Observers do see the potential for compromise on less-explosive topics. For example, several small free-trade deals are now moving through Congress which, in theory, could garner support on both sides of the aisle.

Even those initiatives may not pass muster if unemployment remains stubbornly high and Americans blame other countries for taking their jobs.

"The U.S. remains in a populist era," wrote Mr. Gardner of Keefe Bruyette & Woods. "A change of control in Congress would just be switching flavours … from liberal populism to conservative populism."

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