US Midterm Elections: What Could Move Markets After the Votes Are Counted?

Midterm elections generate plenty of political discussion, but markets tend to focus on a narrower set of questions. How much will the balance of power change? Will the next Congress be able to pass major legislation? And which policy issues could affect economic growth, interest rates or market sentiment?

From a market perspective, I think two things will be particularly important in this election: the margin of control in Congress and the policy agenda that emerges from it.

The Balance of Power

Even if the election outcome is widely expected, markets may react to the size of the margin of control in Congress. A small margin tends to require more negotiation and cooperation between and within the parties to get things done. That would limit the prospects for legislation further out on either end of the political spectrum. A large margin could give the party in control more room to pursue changes in tax, spending and regulatory policy.

Markets generally like divided government because the two parties can check each other’s excesses. But divided government does not eliminate policy risk. Congress will still need to address government funding, the debt ceiling and other must-pass legislation.

The possibility of close races creates an additional risk. If control of Congress depends on a few thousand votes in one or more states, there could be recounts and legal challenges. We may be in political limbo for weeks. In my view, such uncertainty could lead investors to demand higher compensation for holding riskier assets. It could also harden attitudes in Congress, making bipartisan cooperation more difficult.

Fiscal Deadlines on the Horizon

Congress faces some important fiscal deadlines, and the first comes soon. The current continuing resolution funding the government expires on December 11, and Congress must pass another funding measure before then or risk a government shutdown. I think it is likely that Congress will pass another (short-lived) continuing resolution and adjourn; no one wants a federal shutdown over the holiday period.

The fiscal calendar could become more difficult next year. Another continuing resolution could push the funding deadline into 2027. Congress will need to negotiate a budget for 2027 and get agreement with the president, or the federal government will shut down. A shutdown is a serious risk. Later, negotiations over the fiscal year 2028 budget could overlap with the need to raise the debt ceiling.

October 2027 is a key month for the fiscal agenda. It coincides with the start of fiscal year 2028 and could fall near the debt ceiling “X-date,” when the Treasury would exhaust the extraordinary measures it uses to continue meeting the government’s obligations.

I expect the usual last-minute deal to avoid a federal default. But the approach to the X-date could be unsettling for financial markets, particularly if debt ceiling negotiations and a possible shutdown occur at the same time. I believe odds of a technical default are low, but they are not zero.

I think the broader fiscal agenda is unlikely to help. Both parties want more spending, while taxes may become somewhat higher. I do not expect the budget deficit to be lower in fiscal years 2027 or 2028, even with a low unemployment rate.

Oversight Could Move Into the Spotlight

Congress does not have to pass legislation to affect market sentiment. I believe the new Congress, whether divided or controlled by one party, is likely to hold numerous and extensive hearings aimed at shaping the political debate ahead of the 2028 presidential election. Corporate executives could be questioned about large price increases and slow wage gains, with oil and gas companies particularly exposed to political scrutiny. Big Tech and social media companies could also attract attention, while AI may face investigations related to safety, hacking and the economic consequences of automation.

Markets may be especially sensitive to AI-related issues, in my view. While many decisions affecting data centers are made at the state and local levels, potential federal proposals could include tougher safety standards, restrictions on certain AI applications, changes to the tax treatment of AI investment and limits on data center construction. New policies could affect technology companies, utilities, semiconductor firms and other businesses tied to the AI investment cycle.

After the Votes Are Counted

Election results often produce an immediate market reaction, particularly when they differ from expectations, as we just saw with Brazil. However, for markets, I think the more consequential story will be how the new balance of power shapes the policy agenda.

Disclosure

This marketing communication is provided for informational purposes only and should not be construed as investment advice. Any opinions or forecasts contained herein reflect the subjective judgments and assumptions of the authors only, and do not necessarily reflect the views of Loomis, Sayles & Company, L.P. Investment recommendations may be inconsistent with these opinions. There is no assurance that developments will transpire as forecasted and actual results will be different. Diversification does not ensure a profit or guarantee against a loss. This material should not be considered a solicitation to buy or an offer to sell any product or service to any person in any jurisdiction where such activity would be unlawful. Data and analysis do not represent the actual or expected future performance of any investment product. Information, including that obtained from outside sources, is believed to be correct, but Loomis Sayles cannot guarantee its accuracy. This information is subject to change at any time without notice.

Market conditions are extremely fluid and change frequently.

Policy risk is the risk that changes in laws, regulations, tax policy, government spending or other government actions may adversely affect issuers, sectors or markets.

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