MIKE TOWNSEND: In my job, I have the opportunity to travel across the country and meet with investors who come from the full spectrum of political leanings. During the QA portion of my in-person events, it's always interesting to hear what's on people's minds, and I truly enjoy the diversity of inquiries. But over the last seven months, I've noticed that there has been a convergence, and the preponderance of questions have coalesced into a central theme. They almost all start with a lament about how dysfunctional Washington is. There's no end of viewpoints on why that is, but the fact remains that no matter how busy things are, not a lot seems to be getting done. Now we have the August recess starting, and it can feel like the slow trickle of activity is coming to a complete halt. But it's just Congress that is out of session. There are a number of things going on in our nation's capital that have the potential to affect the markets, the economy, and your portfolio. And that's what I want to focus on today. 

Welcome to WashingtonWise, a podcast for investors from Charles Schwab. I'm your host, Mike Townsend, and on this show, our goal is to cut through the noise and confusion of the nation's capital and help investors figure out what's really worth paying attention to. To get things started, let's first look at where we are right now.

The House of Representatives is already out of session for the annual August recess, and the Senate is scheduled to start its break no later than August 7. Both chambers will be out until the beginning of September. From the date this episode first airs on July 30, we will have exactly 95 days to go until the midterm elections. So it's a good time to assess what's been happening, what's still in the queue, and what's likely to happen this fall as we head toward an unpredictable and important election. 

I'm going to kick off with the Federal Reserve, because that's the one thing in Washington that has always and will always matter to the markets. The Federal Open Markets Committee, the FOMC, voted this week to hold rates steady. It was one of those rare times when there was true drama in a Fed interest rate decision. The market was genuinely unsure whether the Fed would hold rates steady or opt for a rate hike. In the end, the committee decided not to hike, but now the market expectations for a rate increase at the Fed's next meeting are rising. There'll be a lot of time for consideration and discussion, and possibly more drama, because the Fed doesn't meet again until mid-September. 

The July meeting was only Kevin Warsh's second one after succeeding Jerome Powell as the Fed chairman. Between the press conference after this FOMC meeting and two days of testimony earlier this month before Congress, we've heard a lot of talk from Kevin Warsh. But in keeping with his style, a lot of talk doesn't necessarily mean a lot of substance.

Warsh has made it clear that he thinks the Fed overcommunicates to the markets and investors, and that the overcommunication reduces the Fed's ability to be flexible and respond nimbly to changing economic circumstances. But even as he dials back the communication and presents a stark contrast to the loquacious Powell, he obviously can't get away with saying nothing for long. So let's parse those comments to Congress earlier this month, along with what he said after this week's FOMC meeting to get down to the key takeaways. 

First, Warsh remains committed to the Fed's 2% target for inflation. This is important because there's been a growing question on Wall Street about whether the 2% target, a goal that has not been hit in five years, was even the right target anymore. But Warsh told lawmakers that, the members of the FOMC "have no tolerance for persistently elevated inflation. And we share a resolute commitment to restoring price stability." His July 14 testimony before the House Financial Services Committee coincidentally came on the same morning that the U.S. Labor Department released June's inflation data, which showed a notable drop to 3.5% after May's reading of 4.2%. On the surface, that seems like progress, but Warsh said the work was far from complete. "There might be some who look at [that] data and say, 'Well, mission accomplished, everything is swell.' That is not my view," he said. And keep in mind, that data came before the restart of the shooting war in Iran, including 12 straight days of bombing of Iranian targets by the U.S. military that contributed to a spike in oil prices, renewed fears of another shutdown of the Strait of Hormuz that affects global shipping, and prompted worries that inflation would bounce back upwards as a result.

Second, it's clear that the importance of Fed independence is on Warsh's mind. On Capitol Hill, he was peppered with questions about whether he would bow to pressure from the White House to lower rates, to which he said he would, "do my job," even if challenged by the president. He went on to call the central bank's independence "sacrosanct," and later stated, "Outside the four walls of the Federal Reserve, there's no doubt a lot of politics. My goal inside the central bank is for there to be no politics." That's reassuring for investors who are eager for a less tense relationship between the president and the Fed chairman. 

Third, he is serious about overhauling how the Fed operates, but he isn't going it alone. He recently announced the creation of five independent task forces, each with three members from the private sector, to examine virtually every aspect of how the Fed operates. These task forces will be looking at everything from how the Fed communicates to how it uses its $6.7 trillion balance sheet to what kind of economic and other data it uses to how it measures inflation and how it thinks about productivity and jobs. The task forces include economists, business leaders, former central bankers, even a Nobel laureate, and are expected to provide recommendations by the end of 2026.

Warsh seems to be using the end-of-year timeline to buy himself some time, which allows him to deflect questions and reserve comment until the task forces have completed their work. In fact, it seems clear that at least for the remainder of 2026, Warsh is likely to say little that boxes him into a particular way of thinking or acting as he waits for those task force recommendations. This measured approach should give the market some comfort, that sweeping changes won't be implemented immediately and without much notice.

Fourth, the Fed chair cannot unilaterally decide which direction interest rates should go, and this week's FOMC meeting was an important reminder of that. The fed funds rate is decided by a committee of 19 Fed officials, 12 of whom have a vote. After the June FOMC meeting, there were nine members who expected there to be at least one rate hike this year, and nine members who did not expect a rate hike, a remarkable even split. And even as Warsh was testifying earlier this month on Capitol Hill, several of his colleagues in the FOMC were giving speeches about how rate hikes may be necessary to tame inflation.

To get the Fed aligned, Warsh will have to build consensus, and that will take time. 

And the fifth and final takeaway: The Fed has multiple tools to influence the economy. It can use open market operations and its massive balance sheet to buy or sell Treasury and agency securities to affect longer-term interest rates, liquidity, and broader financial conditions. It also uses administered rates, including interest on reserve balances, and overnight reverse repurchase agreements to guide short-term money market rates. In periods of stress, the Fed can support credit flow through the discount window. It can set the interest rate at which financial institutions borrow money by selling securities to other institutions and utilize liquidity swap lines with foreign central banks.

But I don't expect we'll see many, if any, of these actions in the next several months as Warsh waits for the independent task forces, especially the one focused on the Fed's balance sheet, to make their recommendations. What's next for the Fed will depend a lot on the data that comes out between now and the next FOMC meeting on September 15 and 16. Between now and then, there will be two jobs reports and two reports on the Personal Consumption Expenditures Index, currently the Fed's preferred inflation measure, although Warsh is looking at a change to that as well. At the end of August, the Fed holds its annual economic policy symposium in Jackson Hole, Wyoming. And traditionally we hear from current Fed officials on a variety of topics during that meeting. 

Tariffs are another major influence on the markets right now, and one which members of the Fed, along with the rest of us, are undoubtedly watching carefully for signs of meaningful impact on inflation.

Last week marked another important milestone in the tariff saga. President Trump's enthusiasm for tariffs is nothing new. He's been talking about them for decades. They are a defining feature of his economic policy in his second term as president. But the Supreme Court struck down the bulk of the president's tariffs in February, saying that the tariffs exceeded the powers given to the president by Congress. Using a provision of trade law that allows emergency tariffs for 150 days, Trump replaced the stricken tariffs with a 10% global tariff. But the 150 days expired on July 24. On the 149th day, the administration unveiled a new set of tariffs using yet another part of the law, Section 301 of the Trade Act of 1974. 

To fulfill the requirements of that law, the U.S. Trade Representative's Office conducted a study and then produced a report saying the United States had found that dozens of countries were using forced labor in producing exports, giving them an advantage over U.S. businesses. The administration announced that a new tariff of 12.5% on imports from 17 countries and 10% on imports from 42 countries plus the entire European Union would begin immediately, effectively replacing the expired emergency tariffs.

Now, there's certainly a lot of skepticism out there about whether the forced labor issue is a real concern, or if it's really just a vehicle for imposing tariffs. Regardless, it is considered by most experts to be on a more solid legal ground than the previous attempt that the Supreme Court overturned. Surprising no one, legal challenges to the new tariffs have already been filed by U.S. businesses. And so, once again, the courts will decide.

Separately, the president has imposed a new 25% tariff on imports from Brazil and announced that a 50% tariff on most imports from Canada would begin in August. The effect of all this has been relatively muted as companies have adapted to the changing tariff regime fairly well. The CEO of General Motors, for example, recently said that she expects tariffs to cost the car manufacturer between $2.5 and $3.5 billion dollars for the year, but the company still expects to make a healthy profit. 

The overall impact of tariffs on broader inflation has been relatively modest, an increase of slightly more than 3% in the cost of goods, according to a Federal Reserve study. But it's worth keeping in mind that services, not goods, make up the larger portion of the U.S. economy, and services are generally not impacted by tariffs. Consumers may still feel the bite, depending on what goods they're buying and how much of the cost of tariffs companies pass on. 

Perhaps the most significant impact of the entire tariff regime is how incredibly difficult it has become for companies to plan. Many companies paid tariffs last year. Some were ruled illegal, some were not. Some companies have received refunds for the tariffs they paid. Some have yet to receive their refunds. Now new tariffs are in place, and these too are being challenged in the courts.

The question now is just how durable are these new tariffs? How companies talk about the impact of tariffs in upcoming earnings calls will be an important piece of information for investors.

We've also all been watching the incredible and ongoing explosion of spending in artificial intelligence. Viewing it all through my Washington lens, there are a couple of developments in the AI space of particular interest to investors. The first is when and whether Congress will put some regulations in place for AI. Lawmakers have been stuck on what kind of regulation is needed. There are countless opinions about what should be the priorities, but a bipartisan pair of House members is taking a crack at it.

Last week, Congressman Jay Obernolte, a Republican from California, and Congresswoman Lori Trahan, a Democrat from Massachusetts, formally introduced a bill that would give the federal government more oversight over the most advanced AI models. It's an attempt to bridge the gap between those who believe tighter government oversight is critical to preventing a catastrophe and those who believe that the federal government should not stand in the way of private sector innovation.

They are also trying to split the difference between those who want a broad federal law that pre-empts individual states from regulating AI and those who think states and localities should be able to create their own regulations. The bill would allow the federal government to shut down any AI models it deems a national security risk, while requiring developers to issue safety reports and submit to independent audits.

Those features are particularly relevant in the wake of recent news that an autonomous agent developed by OpenAI went rogue during a test and hacked into another AI company. That incident was self-reported by OpenAI, but it raised fears about whether the power of some of these AI models can be adequately contained.

The introduction of the Obernolte-Trahan bill is an important milestone, but I'm skeptical that it can get very far in the legislative process by the end of the year. There are just too many differing viewpoints about what constitutes the right level of AI regulation. And frankly, probably too few people on Capitol Hill who understand the rapidly evolving AI technology and its implications. Another risk is that by the time legislation makes its way through Congress, the technology may well have moved so quickly that it renders the bill ineffective.

The second AI-related development I'm watching is the growing public backlash over data centers. Public opinion has swung sharply against data centers, mostly due to concerns that the enormous facilities will result in higher electricity and water prices in nearby communities. A June poll by Reuters found that 57% of respondents would object to a data center being built in their community, and 77% think that AI will make electricity more expensive. New York's legislature recently passed a one-year moratorium on data centers in the state, and a dozen other states have similar pauses in the works. It's an issue that is likely to be a powerful one in November, particularly in local elections. Expect to see a lot of campaign ads this fall that play on the growing concern among voters about data centers.

Elsewhere on Capitol Hill, there's probably no better example of the dysfunction in Congress than the annual slow-moving disaster that is government funding. As a reminder, the process is supposed to work like this: Congress passes a budget that outlines overall spending each year, and then it passes the 12 appropriations bills, which allocate that spending across every federal agency and every government program. And they're supposed to do both those things by October 1, when the government's fiscal year begins. But the last time Congress met that deadline was 1996. And in 13 of the last 15 years, not even one of the 12 appropriations bills was passed by the deadline. 

If they can't meet the deadline, Congress has two choices: either pass a continuing resolution—a short-term extension of current funding levels that buys lawmakers more time for negotiation—or let the government shut down. Either way, it's not an effective way to govern. 

With continuing resolutions now common, it creates a situation in which funding for some programs has just been automatically extended year after year without any analysis about whether that funding is important or to what level, or if it's even still necessary. Even worse, if they fail to pass a continuing resolution, Congress is shutting down the federal government. And we saw the consequences of that last fall when important services were slowed or completely stopped, creating headaches at the airport and causing innumerable other problems across many aspects of daily life. It's not a fun choice. 

As we reach the end of July, Congress has made absolutely no progress on the funding bills for fiscal year 2027. Worried about a government shutdown so close to the election, House Republicans are trying something new. On July 21, they passed a pre-emptive extension to fund the government until December 4, a month after the midterm elections. I can't remember a vote for a continuing resolution happening in July, more than two months before the deadline. It's an acknowledgement that there isn't any plan for funding the government that will pass before October 1—and that it's not really worth even trying. Republicans, who of course control both the House and the Senate, are worried that voters will blame them if the government shuts down five weeks before the election. So they're acting now in hopes of avoiding it.

Now the Senate is negotiating to pass its own version of a funding extension, but it's almost certain to be slightly different from the House version, and the versions have to match. So it will have to go back to the House for a final vote when they reconvene in September. 

Historically, government shutdowns have not correlated with a drop in the stock market. In fact, during last year's record-long shutdown, the S&P 500® went up about 2.4%, largely due to strong corporate earnings and a second consecutive rate cut by the Federal Reserve in the middle of the shutdown. But government shutdowns are disruptive. Last fall, an entire month of jobs and inflation data was lost to history because the federal employees responsible for collecting it were furloughed during the shutdown, depriving investors of key economic metrics. It took several months after the shutdown before economic data had recovered from those missing reports.

I do expect a deal will be reached to pass that temporary extension until early December. At the end of the day, neither party benefits from a government shutdown during the run-up to an election. But it's anybody's guess what will happen when decisions on a funding plan must be made right before the holidays, and it'll be a lame duck session of Congress, where some lawmakers have lost their seats, making those decisions.

Another question I'm hearing on repeat over this last year is, can we still have confidence in government data? As investors, can we trust that inflation figures, unemployment data, economic growth numbers, and other data are being accurately reported by this administration? That concern came to a head last August when the president fired Erika MacEntarfer, the head of the Bureau of Labor Statistics, a relatively obscure government agency responsible for producing and reporting key data like the monthly unemployment figures and inflation measures like the Consumer Price Index. The firing came after a weak monthly jobs report included large downward revisions to previous months' data, raising concerns among some observers about potential political interference in the bureau's work.

For almost a year now, there has been an interim head of the agency, William Wiatrowski, who had been McEntarfer's deputy. And to his and the agency's credit, the BLS has been consistently producing data that has neither caused the president nor the markets to believe the data is being manipulated in either direction to tell a particular story about the economy.

Earlier this month, the Senate committee narrowly approved the nomination of Brett Matsumoto to be the next permanent head of the Bureau of Labor Statistics. Matsumoto is a career BLS economist, a self-described policy nerd. He pledged in his confirmation hearing to fully commit to maintaining the integrity and independence of the BLS. The final step is a vote by the full Senate, which I expect to come before the Senate adjourns for its August recess. Once he's confirmed, Matsumoto will be the face of an agency that needs to rebuild trust with the markets and with investors.

Finally, I want to conclude today with a look at where things stand with the midterm elections, now just 95 days away. In the House of Representatives, all 435 seats are up for election this November, as they are every two years. Republicans have a narrow majority to protect. Democrats need to flip just three seats to win control of the chamber.

But a complicating factor is the flurry of states redrawing their congressional district lines, which began last year in Texas and then moved through California and eight other states this year. On paper, it appears that all the redistricting may give the Republicans an opportunity to pick up about a half dozen seats. Of course, it's voters who will have the final say, but it makes the Democrats' road to the majority a little more difficult.

The battle for control of the House is likely to come down to just a handful of races. The nonpartisan Cook Political Report, which conducts detailed analyses of the congressional races, currently ranks 18 seats as pure toss-ups in November, and just 19 more as leaning to one party or the other. In other words, out of 435 congressional districts across the country, just 37 are considered truly competitive.

The vast majority are solidly red or solidly blue. Which party has the most success in those purple districts scattered across the country will be decisive. Three months out from Election Day, my view is that Democrats are favored to capture the majority in the House. And that's due to a combination of factors, including the president's low approval rating, polls showing Democrats are more enthusiastic than Republicans about voting this fall, rising inflation, and particularly high gas prices, which are for many voters the single most important economic data point there is. Republicans are also battling history. Since 1906, the president's party has gained seats in the House in just three midterm elections. 

Over in the Senate, it's a more complicated map for the Democrats, who need to flip four seats to win the majority. It's a tricky path at best. First, Democrats need to ensure that they keep three seats they currently hold in Georgia, Michigan, and New Hampshire. Senator Jon Ossoff is in a strong position to get re-elected in Georgia. In Michigan, Senator Gary Peters is retiring, and Democrats won't even pick their nominee until the primary on August 4. And that has been a vicious battle between Congresswoman Haley Stevens and a darling of the progressive wing of the party, Abdul El-Sayed. The winner will face former Republican Congressman Mike Rogers, who narrowly lost a Senate race just two years ago by about 20,000 votes out of more than 5.5 million cast. And New Hampshire is one of my sleeper races to watch. Democratic Senator Jeanne Shaheen is retiring, creating an open seat that could be quite close, but isn't really yet on the national radar screen. 

If Democrats can hold on to those seats, then attention turns to flipping four Republican seats. The most likely to flip is North Carolina, where Republican Senator Thom Tillis is retiring, and former Governor Roy Cooper, a Democrat, has been consistently ahead in the polls. 

In Maine, another key battleground state for control of the Senate, the Democrats have had quite the time settling on a candidate to oppose Susan Collins, the Republican senator running for her sixth term. Progressive oyster farmer Graham Platner rocketed to national fame over the past year and won the June primary for the Democratic nomination. But his candidacy was undone by a series of increasingly troubling scandals, and he withdrew from the race on July 10. That set off a scramble to find a new candidate in a matter of just two weeks. Maine Democrats settled on Troy Jackson, a former state Senate president who had lost the primary race for governor earlier this year. It'll be a tall order for Jackson to beat the veteran Collins, but it's a critical seat to the Democrats' hopes for the Senate majority.

Democrats also have their eyes on four competitive races in red states Alaska, Iowa, Ohio, and Texas. They will have to win at least two and possibly three to capture the majority. Not impossible, but not likely. As a result, Republicans remain favored to hold on to their majority by a seat or two. Of course, lots can and will change between now and November 3, so I'll be updating listeners on these key races as we move through the fall. 

There are also a couple of odd situations going on in the Senate that are worth watching. The unexpected death of Senator Lindsey Graham earlier this month shocked Washington. His sister Darline was appointed by South Carolina's governor to fill out the remainder of his term, which runs only until January. It was widely assumed that she was simply a caretaker for the seat. She's never held public office, and her views on just about anything are virtually unknown. But after President Trump encouraged her to run for a full term in November's election, she decided to do so just six days after being sworn in as a senator. There is a special Republican primary on August 11, but Darline Graham is not a shoe-in.

There are two sitting Republican congressmen running in the primary, along with a former governor. Whoever emerges will be an overwhelming favorite in the November race. South Carolina is a very red state, after all. One other quirky race to watch is in Nebraska, where Senator Pete Ricketts, a Republican, is running against an independent candidate named Dan Osborn . There is no Democrat in the race. The Democrat nominee, a political neophyte named Cindy Burbank, won the nomination and then promptly dropped out of the race, allowing for opposition to Ricketts to coalesce around the independent candidate. Ricketts is still favored in very red Nebraska, but it could be much closer than expected and could divert Republican resources away from other races. 

My view is that the most likely result of November's elections is a split Congress, with Democrats controlling the House and Republicans controlling the Senate. A split Congress is a recipe for gridlock, and there's a long held belief on Wall Street that gridlock is generally good for the markets because it prevents either party from overreaching and enacting policies that rattle investors. At the same time, though, there are important issues that will need Congress's attention, from government funding to AI regulation to retirement savings and many more. A split Congress is also an opportunity to find common ground, an idea that increasingly seems lost in Washington. 

So what do all these updates mean for investors? Well, it's a reminder that even when Washington stories aren't dominating market headlines, there's a lot going on in the nation's capital that can influence the markets and that investors should be monitoring. And our promise is that this podcast will continue to be a resource to keep investors informed about the policy and political developments that matter to your portfolio.

That's all for this week's episode of WashingtonWise. With Congress and much of Washington taking a break for the month of August, we're going to do the same. We'll be back with a new episode on September 10, and then we'll be back on our regular every-other-week cadence through the election. Take a moment now to follow the show in your listening app so you get an alert when that episode drops and you don't miss any future episodes. And don't forget to leave us a rating or a review. Those really help new listeners discover the show.

For important disclosures, see the show notes or schwab.com/WashingtonWise, where you can also find a transcript. I'm Mike Townsend, and this has been WashingtonWise, a podcast for investors. Wherever you are, stay safe, stay healthy, and keep investing wisely.