US mid-terms: what investors need to know

Investors are acutely aware that Donald Trump has, as US President, thrown many conventions out the window. The next convention due for the trash can may well prove to be how we think about the mid-term elections, held on 3 November. What they mean for US politics – and hence for investors – could be changing. This reflects the constitutional battle between President and legislators over who holds the power. It also reflects – in an increasingly polarised Washington – the strange bipartisan consensus that fiscal irresponsibility is nothing to worry about.

What are the mid-terms?

All 435 members of the House of Representatives come up for re-election every two years, alongside one-third of the 100 Senators.

In 2024, the Republicans achieved the Trump trifecta: a Republican president and Republican majorities in both legislative Houses. This reduced constraints on presidential power. Democratic control of one House should reduce presidential freedom of action. Control of both should amplify this; winning 60 Senate seats would supercharge it, by giving the Democrats the ability to push game-changing legislation through Congress (the collective name for both Houses).

The AI headlines have darkened recently. Several industry insiders claim a significant chance that it will wipe out humanity, possibly within a decade. AI business leaders propose a frontier model development ‘pause’ to give them the time to make it safer. Some of them are calling for government regulation, although Trump is not in favour.

A Democratic-controlled Congress might have the power to rein the industry in, empowered by the weight of public opinion as much as by electoral success. Even before fearing for their lives, voters were voicing concerns about job losses and environmental pollution. Many states and municipalities have declared a moratorium on development. Mid-term candidates have latched on to this.

However, legislators will also be highly sensitive to the risk of Chinese models overtaking US ones, because of a pause on US development. Both parties have adopted an aggressive stance towards China. It’s important for investors to monitor this situation because much of this year’s corporate earnings growth has been driven by the surge in capital spending (capex) on data centres. That spending extends beyond the US, including to chipmakers in Korea and Taiwan.

The cost of living

This will decide many voters’ minds. The hell-for-leather cycle of AI-related capex has contributed to inflation consistently above the US central bank’s 2% target. Higher energy prices, pushed up by disruption from the Iran and Ukraine wars, have added to the pressure. Trump’s tariffs have also increased inflation.

Democratic victory is unlikely to have much effect on tariffs, generally imposed by presidential executive order. But could Democratic control over one or both Houses make an end to the Iran War more likely? Since the President has prosecuted this war with no Congressional support, it’s not clear that election results will greatly change the situation. Indeed, many policy analysts think Trump may become even more hard-line on Iran once he doesn’t have to consider the electorate, whatever the result.

The fiscal situation

The US 10-year government bond yield hit 5% in September. At least in part, this reflects concerns about the sustainability of government finances. In August, US gross federal debt hit $40trn – around 125% of GDP. What difference would Democratic electoral success make?

Tax cuts under the One Big Beautiful Bill Act, combined with the costs of the Iran War, mean that the country is running an annual deficit equivalent to 6% of GDP. The President also recently dangled the carrot of a $5,000 “dividend” to all US adults should the Republicans retain their House majorities. This would cost around $1.2trn, pouring more gasoline on the fire.

In fact, however, neither side seems keen to rein in spending. Democrats will look to increase social and welfare spending, probably funded by higher taxes on wealth – especially if more left-wing ‘progressive’ candidates are elected. In the absence of an AI-inspired productivity boom – accelerating economic growth and boosting tax revenue – a bond market crisis is probably the only cure for this fiscal incontinence.

Fiscal incontinence

Joe Biden narrowed the deficit after the pandemic, but it remained well above the historical average. Under Donald Trump, it’s projected to get even larger.

The case for deadlock

This time round, current opinion polls (and betting markets) suggest that the Democrats will take control of the House of Representatives. The Senate is a much closer call – and 60 Democratic Senators looks extremely unlikely.

Leaving aside political views, many investors argue that either a split Congress – with each party controlling one House – or one unified against the White House is the best outcome for investors, at least over the four years of a presidential term. That’s because dramatic changes are less likely, allowing everyone to get on with their business with less interference.

Given Trump’s mercurial nature and apparent disregard for legislators, this might be the exception that proves the rule. He’s repeatedly tested his power against other institutions of the US state, including both Houses, by ignoring constraints either spelt out in law or set out as convention – and frequently won. So we don’t expect to experience a suddenly smooth political ride, even if the Democrats are electorally successful.

Meanwhile, one time-honoured convention – that governments should limit peacetime deficits – had already been abandoned under Democratic President Joe Biden. In other words, what investors need to know is that what they used to know about the mid-terms can, perhaps, no longer be relied upon. Good to know.

On the investor watchlist

Upcoming elections elsewhere in the world matter to investors, too. Will Prime Minister Benjamin Netanyahu, who with Trump began the Iran War, remain in power after Israel’s October election? His victory would make an inflation-busting end to the Iran War harder.

April sees France’s presidential election, with National Rally’s leader, Marine le Pen, leading in the polls. Italy’s Giorgia Meloni will also face the voters next year. She has brought stability to Italian politics by presiding over the longest-lasting government of modern times, albeit one that hasn’t boosted the country’s appallingly low underlying growth rate. While there’s no federal election due in Germany, local election wins by the far-right AfD party, combined with plummeting confidence in Chancellor Friedrich Merz, mean we cannot rule out change.

This all raises the possibility of more ‘populist’ governments – governments that tend to have little respect for political norms, including a belief in sound finances, because they feel that existing elites have betrayed the people. This could hit the prices of government bonds – particularly long-term debt.