Republican sweep is the 'real tail risk for markets'

A clean sweep for the Democrats

"We think that a Democratic sweep would be neutral to mildly positive for the fiscal outlook. Congress could restrain Trump’s expansionary agenda and, with it, the deficit. Negotiations would be confined to must-pass items, such as the budget and the debt ceiling, with the latter expected to be hit at some point in 2027. Raising or suspending the ceiling requires congressional approval, with an extended negotiation potentially unsettling investors. A Democratic sweep would not, however, mean Democrats set fiscal policy for the rest of the term, given that the president can exercise his veto and they are unlikely to reach the two-thirds Senate majority needed to override it.

"Would a Democratic sweep reverse the course of yields entirely in the months that follow? Most likely not, so long as the Iran war continues to drag on, since it has added an inflationary risk premium across the curve, while inflation expectations remain elevated and corporate bond issuance to fund AI investment is adding to supply. That said, we would expect any move in the dollar in this scenario to be contained, as the outcome is already largely priced in by markets, and the real fiscal test for a Democratic Congress facing a Republican president, negotiations over the debt ceiling, isn’t expected until 2027."

Democrats flip the house, not the Senate

"We think that the fiscal policy implications of this scenario are broadly similar to a Democratic sweep. Congress would again be limited to approving must-pass items, such as the debt ceiling or the federal budget, with the latter potentially triggering government shutdowns if consensus is not reached. This could create some market unease, along with a temporary slowdown in the US economy if the shutdowns were to drag on.

"Under this scenario, we would expect a more adverse reaction in the dollar than scenario a), in part as this is not fully priced in. A Republican Senate would also make it easier for Trump to confirm nominees to the FOMC. The appointment of members that more closely align with his preference for a lower fed funds rate could both dampen expectations for higher US rates and amplify fears over Fed independence."

Republicans retain full control of Congress

"An unlikely Republican sweep, which would preserve the status quo in Congress, is the real tail risk for markets. This would likely mean more government spending, possible tax cuts, wider deficits and higher Fed rates, despite Trump being able to confirm a new nominee to the FOMC.

"Such stimulus could boost growth at a time when the US economy is already strong, driven by elevated AI related investment and a resilient labour market. With inflation already above target, the risk is that additional demand-side pressures compound the supply-side shock from the Iran war, entrenching price pressures and lifting expectations for Fed rates. While the medium-term path of the dollar would depend on the specific policies announced, we would expect a dollar rally on election night."

Republicans retain control of the House, lose the Senate

"The fiscal implications here would be similar to the other split-Congress scenario: gridlock, with Congress limited to must-pass items. The Fed angle is different, however, as a Democratic Senate could block the president’s nominees for the FOMC board, which may ease fears over Fed independence.

"This outcome is highly unlikely, however. A Democratic Senate is harder to win than a Democratic House, and the electoral arithmetic means that any political environment strong enough to deliver the required Senate gains would almost certainly produce a Democratic House as well. We assign this scenario a negligible probability, consistent with historical precedent: since World War II, the president’s party has virtually never lost the Senate in the midterms while holding the House."