US midterms: A political shake-up, but what changes for markets?

This article was originally published in DFM Wealth Magazine on 4 November. 

Big news is Democrats have won both houses. It was a much bigger margin of victory than expected – it was a repudiation of Trump’s war in Iran, inflation, the cost of living and affordability. It raises a number of interesting points to consider, not least of which is the politicisation of the datacentre rollout and tightening of AI regulation. Trump still has his presidential veto, so the actual impact of a pushback may be less of an effect, but it does raise further questions at a time when the AI trade has become more vulnerable. It also raises the question of US growth – a lot of this has been driven by AI capex spending and does that now become more vulnerable?

We now have legislative gridlock in the US – Trump is unable to pass any further domestic legislation without by partisan approval. But on the other hand, he still has his veto to block any Democratic bills. Sector wise, this may negatively impact defence and tech and boost healthcare, given Democrats’ focus on affordability.

The reality is that Trump will face greater scrutiny and can no longer make federal appointments to the Supreme Court etc. but he can carry on with tariffs under his executive powers, and whilst he has lost much of his ability to change legislation, he retains much of his ability to change policy through his executive powers.

What will be interesting to see is whether this creates deadlock, or whether there are compromises on spending and economic policy. A divided government also can be positive as it means less large legislative surprises and more compromise. The new Congress doesn’t sit until 3 Jan 2027, so there is still time for the Republicans to push through a limited agenda.

Markets were down initially but have bounced back. Treasuries have two competing effects – potentially lower yields from fiscal constraint, but also gridlock creates budget uncertainty, which is a negative headwind. Tax cuts are off the table, which is positive, but budget standoffs and debt ceiling confrontation could push yields higher. The bottom line is that whoever is in charge, the market will focus on inflation, growth and the deficit.

For risk, this could go either way. The focus continues to be on the path of rate hikes, inflation and growth. This has not changed, but if we do see a pushback on datacentre buildout and less capex, then this could slow growth. Gold is up a bit as a result of USD weakness. Oil is down a bit. It will be interesting to see how Trump reacts to this and whether the peace talks with Iran result in anything meaningful that does then not change.

This will impact sentiment in the short term, rather than have any real material impact until we see how Congress and the President interact next year. Fixed income still looks attractive from a yield perspective. The focus will continue to be on growth, inflation and interest rates. The consumer remains robust but it is still very much a K-shape. If we continue to see equity losses then consumer sentiment may well change given a lot of consumer activity has been built upon very strong equity markets. For Europe, it makes little difference. The headwinds remain the same. It will be interesting to see whether the USD does remain under pressure, which will give gold some support after its recent weakness.