US voters have changed the balance of power in Washington. The Republicans have lost their majority in both chambers: victory has been declared in the Senate and there are still a few seats to be declared necessary in the race for the House of Representatives.
The outcome gives the Democrats control of Congress, significantly limiting the Government's legislative agenda for the remainder of its term.
The initial market reactions have been as follows: the S&P 500 has fallen by 0.5%, the yield on 10-year US Treasury bonds stands at 4.94% and the US dollar was trading at 0.89 euros at 7:00 CET.
Our Immediate Interpretation
The outcome limits the Government's ability to push its national agenda through Congress. A greater fiscal expansion is now less likely, while spending, taxation, and major regulatory initiatives will face increased scrutiny. Democratic control of both chambers also increases the likelihood of stricter oversight from Congress and renewed debate on fiscal policy.
This does not mean that political uncertainty disappears. With fewer options in Congress, the White House may increasingly resort to executive powers, particularly regarding tariffs, sanctions, immigration, and foreign policy. In our opinion, a tougher US response towards Iran following the midterm elections constitutes a significant risk that could push oil prices and inflation higher.
For investors, the composition of Congress is important, but the next market move will still be determined by growth, inflation, and interest rates.
What This Means for Markets
Equities: A crushing victory for the Democrats removes an immediate source of political uncertainty but also implies greater control over the Government's national agenda. A smaller margin for fiscal expansion could curb growth, while the renewed debate on corporate taxation and high incomes could affect different sectors in varying ways. Historically, US equities have performed well after midterm elections, partly because investors gain greater visibility on the political context. However, high stock valuations and elevated bond yields may leave less room for a rally post-elections, making profit growth particularly important.
Fixed Income: A divided government may support Treasury bonds by limiting further fiscal expansion. However, blocking new spending is not the same as reducing the existing deficit. Therefore, persistent deficits and high Treasury issuance could limit how much long-term yields decline, even with greater Congressional control over the Administration. Inflation and Fed policy are likely to weigh more heavily on bonds than the election outcome, while any new rise in energy prices could complicate the outlook.
The US Dollar and Markets in General: In the case of the US dollar, the immediate reaction may reflect more relief and investor positioning than a lasting trend change. In the long term, relative growth and Federal Reserve policy should remain more significant factors. As Congress limits the national agenda, greater use of executive powers regarding tariffs and sanctions could also have disparate effects across different sectors, currencies, and regions.
What We Will Analyse
The first test will be whether the outcome leads to orderly negotiation or recurring confrontation over spending and the debt ceiling. We will also observe whether the prospect of lesser fiscal expansion affects Treasury yields, although the initial reading is likely to be diffuse: the quarterly Treasury refinancing taking place later today and the employment data on Friday will also influence bond markets this week. Beyond that, we will watch whether the Government leans more towards tariffs, sanctions, or other executive measures, and how corporate profits respond to growth and financial conditions.
The elections provide a clearer picture of the situation in Washington. However, by themselves, they do not determine the outlook for the markets.
