US midterms: Blue wave ushers in gridlock

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What happened?
Vote counting is continuing across the US, but early results and projections point to a strong Democratic performance in congressional and state elections. The Democrats will retake both the House of Representatives and Senate, according to the Associated Press and the major TV networks, bringing unified Republican control of Washington to an end.

While a strong showing for Democrats was expected, the scale of their advance has outstripped what markets had priced ahead of election day. Japan’s tech-heavy Nikkei closed 1.4% lower, but sentiment has since turned, with European markets broadly up for the day and Nasdaq and S&P 500 futures currently both 0.2% higher. Ten-year US Treasury yields fell 4 basis points to 4.92%.

What do we think?
Midterm elections often serve as a referendum on the incumbent administration. The results, while stronger than markets anticipated, are consistent with the negative presidential job approval ratings and elevated oil prices ahead of the vote. The outcome is a setback for President Trump and Republicans, but we would be cautious about interpreting it as a broader Democratic policy mandate.

Expect sand in the legislative gears, not sharp policy changes. Control of Congress will give Democrats greater oversight of the Trump administration, the authority to confirm or reject presidential appointments and nominations, and greater influence over spending and debt-limit negotiations. It will also give Democrats a platform to test policy proposals on areas including social security, health care, and AI regulation ahead of 2028. However, President Trump retains veto power, while Senate rules and a divided government should constrain sweeping tax or spending legislation. The executive branch retains broad authority over tariffs and foreign policy. This suggests greater legislative friction ahead, rather than a reversal of the administration’s agenda.

Democrats will need to prove they can govern. Oversight and investigations are likely to increase after this result, but voters may ultimately judge the new Congress on whether it can also make progress on legislation and fiscal negotiations. Following the results, President Trump suggested he will work with Democrats and that he doesn’t want to veto everything. Markets may begin to price in potential 2028 outcomes, but we think this is premature and anticipate investors will soon refocus on fundamentals.

Debt talks remain the clearest risk for bonds. The next Congress will confront 2027 debt-ceiling negotiations, which we think could result in scheduled social-program cuts being softened and defense spending rising. Together, these measures could reverse an expected narrowing in deficits and increase Treasury supply. Potential political brinkmanship next year could also heighten bond market volatility. Still, we expect inflation to moderate, the Federal Reserve to finish raising rates, and Treasury yields to settle lower.

AI volatility may pick up on politics, but underlying demand is still solid. Greater congressional oversight will not necessarily derail the AI investment cycle. Broad federal restrictions would face legislative and presidential constraints, while state and local rules remain more important for data center timing and location. The composition of state governments, including the result in Texas, may prove more consequential for individual data center projects than the change in congressional control.

AI infrastructure demand remains strong, and we have raised our aggregate AI capex forecasts to USD 1.0tr in 2026 and USD 1.4tr in 2027. Still, global investors are placing greater weight on the risks surrounding overinvestment, financing, and monetization. Higher volatility could become the new normal, favoring financially strong platforms and infrastructure providers, as well as diversified exposure across the AI value chain.

How do we invest?
In line with our guidance prior to the vote, we anticipate a more definitive Democratic outcome could drive near-term volatility, particularly in tech and other areas sensitive to greater regulatory scrutiny. However, we do not think the result changes the medium-term fundamental outlook sufficiently to justify an immediate strategic shift in portfolios.

Beyond politics, strong earnings support our constructive view on equities. We think investors should actively look to reduce single-stock concentration, rebalance oversized technology exposure, and, within technology, tilt toward quality companies across the AI value chain. Periods of politically driven weakness can be used to rebalance or build exposure gradually, rather than to abandon long-term positions indiscriminately.

We also see attractive income and diversification potential in high-quality bonds, particularly in short- to medium-term maturities. Investors can use volatility to rebalance or build exposure gradually, adjusting portfolios only if policy changes materially alter the fundamental outlook. Current yields offer attractive income, although persistent deficits and heavy issuance underpin our caution toward the longest maturities.