As the US congressional elections approach, polls are increasingly indicating that Democrats will gain control of at least one of the two chambers. Historically, in periods when the legislative and executive branches of power have been controlled by opposing parties, there have been few major changes in policy and markets have often reacted favorably.
This, however, does not mean that US and global investors have no reason to pay close attention to the upcoming vote. Since the COVID pandemic, the growing importance of US fiscal policy to markets has made every election relevant to investors.
Furthermore, this year's midterm elections could also offer valuable insights into the longer-term direction of US policies, from interest rates to inflation to artificial intelligence. These insights could help investors spot potential opportunities in a changing environment.
Congress divided or victory in both houses?
One possibility is that Republicans retain the Senate while Democrats gain control of the House of Representatives. This would limit the ability to pass new laws and increase the potential for congressional oversight of the president's actions. The competition for the Chamber includes around 29 contestable seats or with an uncertain outcome, and a shift of around 4-5 seats could lead to a change in the majority.
More recently, the possibility has increased that Democrats will win control of the Senate as well as the House. A Democratic victory in both chambers could lead to greater attention to health care, the cost of living, consumer protections and other Democratic campaign issues.
Legislative gridlock between a divided or Democrat-controlled Congress and a Republican president would likely limit additional spending. Treasury yields may experience less upward pressure, although the same outcome may be less conducive to economic growth.
The prospect of a divided or Democrat-controlled Congress taking office in January could push congressional Republicans to implement as many of their policy priorities as possible during the post-election session before the new Congress takes office, before the end of the year. These could include an increase in defense spending linked to the war in Iran, increased funding for agriculture and changes to infrastructure spending. Overall, these measures could constitute a package of new spending equal to up to 0.5% of GDP.
Regardless of the election outcome, however, President Trump will retain the ability to take action through executive action on trade, regulation, foreign policy and more.
Let's not forget the debt
Politicians of both parties are running campaigns focused more on concerns about inflation and the economy than on the federal government's growing debt. However, the federal debt ceiling will need to be raised within the next year, and how this will be done is relevant to markets and, potentially, the government's credit rating.
Investors will watch whether Republicans try to raise the cap during the year-end session following the election or whether Democrats can use the issue as negotiating leverage next year, following a possible victory in both chambers.
While candidates from both parties are tapping voters' concerns about inflation and the cost of living, the outcome of the election may have little influence on rising prices. This is because the current surge in inflation is fueled in part by energy supply problems resulting from the war in the Middle East. Unlike demand-driven inflation, the Federal Reserve's ability to counter supply-driven inflation is limited; therefore, cost-of-living sustainability will likely remain a challenge for both policymakers and consumers, regardless of who controls Congress.
Will artificial intelligence be regulated?
Investor expectations about the future of artificial intelligence have become determining factors for both stock and bond markets. However, voters are increasingly concerned about the risks that AI could pose to many aspects of their lives, and politicians' campaigns have responded by calling for regulation of an industry that has so far largely self-regulated. Although the Trump administration is predominantly opposed to public regulation of AI, the outcome of the election could lay the groundwork for future regulation.
Below are some possible scenarios. A Democratic victory in both chambers could lead to greater scrutiny of data centers and other AI-related developments, especially due to concerns about costs and security. An accident or other event could serve as a catalyst for regulation. Absent an immediate catalyst, the 2028 election could see candidates campaigning on AI regulation, with possible bipartisan support emerging in 2029. National security concerns could favor a looser regulatory approach, as policymakers view AI as strategic infrastructure and worry that regulation could slow innovation relative to China.
Why it matters to global investors
Non-US investors should monitor Congress' possible end-of-year spending package as it could affect economic growth, interest rates and inflation in the US, which could have implications for asset allocation. If the election results do not lead to a year-end package, the US could see a fiscal tightening of 0.5% next year, a significant change from the post-COVID period. Investors may also be watching how the growing divide within the Democratic Party between moderates and progressives plays out come Election Day. The results could indicate whether the 2028 election will focus on spending on social benefits and health care reform or on a greater compromise on tax policy.
