US midterms: Democratic sweep changes Washington more than Wall Street
The Democratic Party has won control of both the House of Representatives and the Senate in the US midterm elections. The result represents a convincing wave, with decisive gains in states and congressional districts. Democrats will hold at least 240 House seats and 54 Senate seats. That gives the party control of Congress during the final two years of President Donald Trump’s second term. Financial markets initially responded with a sharp decline in equity futures, but quickly recovered. The US dollar weakened somewhat and US interest rates remained quite stable.
First, what exactly are the midterms? Halfway through a presidential term, voters elect members of the House of Representatives and the Senate, which together form Congress. Congress debates and votes on legislation. The party that controls a majority in Congress can therefore exercise greater influence over legislation and government oversight.
The election was widely viewed as a test of voters’ support for the Trump administration. Although economic growth and corporate profits remained supportive of financial markets, polling had already indicated that the Republicans would lose some ground in Congress. Democrats benefited from Trump’s low popularity among voters. Concerns included Trump’s handling of the Iran war, persistent inflation and high energy costs. The result can therefore be interpreted partly as the traditional setback that a president’s party often experiences in midterm elections, and partly as a response to concerns about the cost of living, foreign policy and the direction of the economy.
Implications for investors
A Democratic Congress will make it substantially more difficult for Trump to pass new legislation. Democrats will control congressional committees and can hold hearings, issue subpoenas, investigate the administration and scrutinise individual industries. Democratic control of the Senate also allows the party to delay or reject presidential appointments, for example, of judges, ambassadors and senior government officials.
However, the immediate economic consequences should remain limited. Trump has already implemented a significant part of his programme, while previously enacted tax and spending legislation will remain in force. He will also retain extensive authority over trade, foreign policy, immigration and the federal government. Anticipating a Democratic victory, Trump said: “I guess I’ll become Mr. Veto,” signalling that he would make greater use of presidential vetoes to block Democratic legislation. After the results he already posted on social media “VETO”.
Bonds may receive modest support
For bonds, this may have been the most favourable of the plausible electoral outcomes. A divided federal government reduces the likelihood of further unfunded tax cuts or large new spending packages. That should limit, rather than eliminate, upward pressure on Treasury yields. The structural budget deficit and high interest costs will remain important, however. Disputes over government funding and the debt ceiling may also create periods of volatility.
For equities, the initial reaction may lead to greater volatility because investors must price in more investigations, regulatory uncertainty and political confrontation. Financial services, crypto, fossil-fuel producers and parts of the AI ecosystem could face additional scrutiny. Conversely, renewable energy, infrastructure, hospitals and companies connected to public-health programmes could benefit from the change in congressional priorities.
Importantly, history suggests that investors should not overreact to the political result. Midterm-election years have generally been the weakest part of the four-year presidential cycle, while the year immediately following the midterms has historically been the strongest. The explanation may be less about which party wins and more about uncertainty declining once the election has passed. This historical pattern is encouraging, but it is not a forecast and does not eliminate normal market risks.
Washington changes, but fundamentals prevail
The Democratic sweep will considerably alter the balance of power in Washington, but its broader market impact is likely to be limited. Trump retains executive and veto authority, while the Democrats lack the supermajorities needed to override vetoes. This limits their ability to reverse existing policies and points to greater political gridlock rather than a fundamental shift in economic policy.
Finally, the period following the midterms has historically been favourable for equities. Combined with continued economic growth and high investment in AI, defence and sustainable energy, this supports our positive long-term outlook for equities, even if political confrontation produces volatility along the way.
Thomas Pellegrom
Investment strategist