The Blue Tsunami and Reflections on the Midterm Elections: What Happens Next?

Democrats took the House and Senate in the US midterm elections, with a few races still being counted. The magnitude of the gains in the Senate was the surprise, but even a Blue Tsunami does not mean Democrats can get everything they want. What might come next, from budget and debt ceiling fights to AI, tariffs and foreign policy?

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Divided Government

On current count, Democrats flipped 40 seats in the House of Representatives, taking control. Votes are still being counted. This was a high-conviction consensus outcome.

In the Senate, toss-up states all went in one direction, a twist few saw coming. Final counts from Alaska and Mississippi are pending and may face challenges, but currently, Democratic candidates lead Republicans in both states.   

Despite the Blue Tsunami, Democrats will need to negotiate with the Republican minority in the Senate and with a Republican president to get anything done. 

Democrats are still short of the 60 votes needed to end a filibuster in the Senate, so Republicans can still force negotiations. (There has been talk of Democrats abolishing the Senate filibuster rule, but I think that’s unlikely with a Republican president.)

It takes a two-thirds vote in both chambers of Congress to override a presidential veto; Democrats are nowhere near that threshold. It also takes a two-thirds Senate vote to convict a president who has been impeached in the House.

A (Very) Lame Duck Congressional Session

After the election, the current Congress will briefly return to Washington before the newly elected Congress takes office. Known as the “lame duck” session, I expect it to be relatively uneventful. Here’s what’s on deck:

• Continuing resolution (CR): Congress will need to pass a new CR to keep the government open (the current CR expires December 11). The new CR will likely last until sometime in Q1. I expect Democrats to vote for it; no one wants a shutdown before Christmas, and Democrats would prefer to negotiate a budget in the new Congress. There will probably be few riders on the new CR.
• National Defense Authorization Act: Congress must pass this legislation annually to authorize US defense programs. It will probably have few amendments. 
• Reconciliation budget: Republicans may try to pass a small reconciliation budget that could include increases in defense spending and a rise in the debt limit. President Trump will likely urge congressional Republicans to do this. A reconciliation budget can pass on a simple majority basis, so Republicans could pass it if they want, but I think it will face an uphill battle from fiscal hawks and Republicans headed for retirement who may not feel obliged.
• Permitting reform: There have been repeated bipartisan attempts to pass permitting reform. I think it could happen next year when Democrats have more negotiating power, but not in the lame duck session. Trump has some leverage; he can continue challenging wind power projects until he has a deal.  

Budget & Debt Ceiling Fights: Coming Attractions

First, the budget. I anticipate a fight over the budget for fiscal year 2027 (which started October 1) and then a fight over the budget for fiscal year 2028. 

If there is a failure on either budget, we get a federal shutdown.

Democratic leadership is willing to make deals, I think, but they will have to bring in party members further to the left. Incoming Democratic leadership will enjoy a wide enough margin of control to sideline marginal factions in a vote.

Republicans and Trump want more defense spending. I think they will get it, although not as much as they want. The price will be reversing the budget cuts for Medicaid, Affordable Care Act subsidies and SNAP benefits from the One Big Beautiful Bill Act.

Between extra outlays for defense and medical measures, spending will rise. The deficit will be higher, driving interest rates higher.

On the debt ceiling, I expect a fight over the summer, coming to a conclusion in late summer or early fall. It could be a difficult time for financial markets. But I expect a last-minute deal. Trump will likely need to make concessions.

Data Centers and AI

Domestically, I see potential threats to AI and data centers.

AI development by itself will be regulated mostly at the federal level. Trump is very pro-AI. There is likely a deal to be made on federal regulation on AI safety.

Democrats are likely to use their leverage on the budget and debt ceiling to demand that 100% expensing of capital expenditures be removed for AI and data centers.

Data centers are mostly regulated at the state and local levels. They remain controversial. State governments that are now run by Democrats are likely to press for revoking any tax benefits data centers receive, raising revenue but slowing construction. States could also impose water limits, set requirements for onsite backup power, mandate labor requirements, ban non-disclosure agreements during permitting, and require data centers to pay grid costs to protect ratepayers.

The top-five states for building data centers—Virginia, Georgia, Ohio, Pennsylvania and Texas—all now have Democratic governors with a skeptical view of data centers. Democrats also flipped the governorships for Nevada and Michigan. I expect more moratoriums on building. Of 33 local measures proposing restrictions on data centers, 26 passed with others still being counted. 

Affordability?

It’s the term that defined the election season. What is the new Congress going to do about affordability when they meet in January? There are more questions than answers.

• House prices: High prices won’t come down without a lot of new supply, which takes substantial construction and time. I am not upbeat on that.
• Mortgage rates: High mortgage rates are also an issue and they aren’t measured in the Consumer Price Index. Lower mortgage rates will require lower Treasury bond yields—not so easy to do with the Federal Reserve (Fed) tightening and a big budget deficit. Trump and Congress may try to subsidize mortgages. We have been there before: lower mortgage rates without more housing supply only boosts prices. Or lending standards can be relaxed. We have been there before, too, and it didn’t work out. 
• Oil: Allowing Iran and Russia to return to the world oil market would help lower oil prices and refined product prices, but is that where foreign policy is going? Substantial domestic drilling could help. Do Democrats want that?   
• Monetary policy: How much tightening do we want the Fed to do to bring down inflation? And how much should Congress cut the deficit? Would we accept a higher unemployment rate?  
• Tariffs: Does Congress want to get rid of all of Trump’s tariffs? Even if Trump would accept it, will Democrats get behind free trade? 
• The dollar: A stronger dollar could help reduce prices, but it comes with a larger trade deficit.   
• AI: The AI boom has boosted the prices of all electronics. Do we want to end the AI boom?

If fixing affordability were easy, we would already have done it.

I think Democrats and Trump will reach for populist measures in the hope of improving affordability:

• A boost to the federal minimum wage is likely. 
• A cap on credit card interest rates may be coming, and perhaps regulations on interchange fees.
• Drug price controls of some kind seem likely.

Foreign Policy

President Trump will still have full control of foreign policy and the military as commander-in-chief. I think he will spend his last two years aiming to create a legacy. Trump will likely continue to push for some kind of deal between Russia and Ukraine. He seems to want Ukraine to make more concessions than it is willing to do. I expect continual pressure on Cuba to secure regime change. The situation with Venezuela may continue as-is, although domestic opposition in the country may insist on regime transition. Relations with Israel seem likely to get worse amid pockets of waning support in the Democratic and Republican parties. 

Iran

I expect an ongoing cold war with Iran, which will likely flare into an occasional hot war. Escalation in November remains my baseline, though the odds may have somewhat decreased. A successful conclusion to the conflict with Iran is a legacy Trump wants, and with the midterm losses, the price of continued engagement has already been paid.

Congressional Democrats, with some Republican support, may pass a war resolution to block Trump; Trump would veto such legislation, and a veto override is unlikely.  

For now, Israel will cooperate with Trump. Prime Minister of Israel Benjamin Netanyahu remains in power for a while longer after Israel’s confused election, and he is committed to military action.   

Trump would like to open the Strait of Hormuz to normal shipping while squeezing Iranian exports. That won’t be easy. My current view is that crude oil prices will remain high, albeit volatile, for the remainder of Trump’s term in office.

Tariffs

I don’t think the tariffs were a major issue in the election, except that the trade fight with Canada may have helped tip Senate races in Michigan, Ohio, Iowa and Maine, states with large trade ties with Canada. 

There are tariff investigations going on, and I expect further tariffs to be imposed, mostly involving products rather than countries. At the same time, Trump may try to negotiate more trade deals. I don’t think Congress will try to reverse Trump’s tariffs for several reasons:

• Trump would veto any Congressional attempt to overturn the tariffs. 
• Repealing Trump’s tariffs would not be a winning issue in the next presidential election.  
• Repealing all of Trump’s tariffs would be expensive, and Democrats need revenue for their spending plans.
• For the most part, Democrats are more protectionist than Republicans, which only changed with Trump. Note that former President Biden did not reverse the tariffs that Trump imposed in his first term.  

The Fed

Post-election, I expect the Fed to continue to be guided by its dual mandate. Currently, the focus is on fighting inflation.    

I think that attacks on Fed independence will fade. Trump will have little power to influence the Fed going forward.  

That doesn’t mean that the Republican-appointee Chairman Warsh has clear sailing. Congressional Democrats will likely see him as an ally of Trump; they’re also unlikely to cheer on further Fed rate hikes. Warsh will face serious scrutiny with Democratic Senator Warren as chair of the Senate Banking Committee.  

There are no imminent Fed leadership changes, but a few situations bear watching:

• Jerome Powell’s Board term expires in January 2028, but Powell could resign early if all allegations of criminality against him are dropped. That would create the next scheduled vacancy, although the Senate might delay confirming a successor until Trump is out of office. 
• Fed Governor Philip Jefferson’s term as Vice Chair ends in September 2027, when the president could nominate another sitting governor for the position (that would require Senate confirmation).
• If Governor Lisa Cook leaves the Board through removal or resignation (I assign low odds here), that would create an earlier vacancy. Democratic Senators may opt not to confirm a replacement.

Deficit and Entitlements

The trust funds for Social Security and Medicare will be exhausted in six to seven years. It was not an issue in the campaign.   

I don’t expect congressional Democrats to make the deficit an issue; there will be no proposals to reduce it. But there may be a fight over the debt ceiling. 

The deficit will become an issue whenever financial and currency markets force the government to make it an issue.

Do Not Go Quietly into That Good Night

Some say that Trump is now a “lame duck.” In a sense, with both chambers of Congress in the hands of the opposition party and with no opportunity for reelection, he is. It will be hard to get much done aside from what is absolutely necessary, like the budget.

But he still has powers for foreign policy and the military, for tariffs and for issuing executive orders. Despite the election losses, I don’t think the White House intends to back down. The administration has little to lose by becoming even more aggressive. The Supreme Court could be very busy in the next two years as executive orders and regulatory rulings get challenged.

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.

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