- The Democrats achieved a full sweep of Congress and won a majority of governorships in the midterm elections. Results are not definitive at this stage, but the Democrats have secured a decisive majority in both the House and the Senate. Until end-August, the Republicans looked more likely to retain control of the Senate but high gas prices fueled voter discontent. Nevertheless, the near-term policy outlook will be relatively unaffected as the Democrats still lack a filibuster-proof majority in the Senate and President Trump has veto power to block legislation.
- The results could mean a deadlock in fiscal policy, with rising risks of a government shutdown, a debt-ceiling standoff and higher fiscal deficits. A Democratic Congress is likely to block the White House’s flagship proposals, and funding and debt-ceiling deadlines could converge in Q4 2027–Q1 2028, though the Republicans could manage to pass more defense funds and/or raise the debt ceiling before year-end. A divided government should still find compromises: In 2027, Republicans could get c.USD90bn in supplemental defense spending to replenish munitions (unless the White House re-escalates the conflict with Iran), while Democrats could secure higher non-defense spending and delay some health and nutrition cuts from the One Big Beautiful Bill (OBBB), resulting in a slightly loose fiscal stance (0.2% of GDP). The federal deficit could widen from -6.2% of GDP in 2026 to -6.6% in 2027. Housing policy could also be an area of bipartisan compromise.
- Tariff, immigration and regulatory policies will remain largely executive-led. We expect the effective US tariff rate to reach around 8.5% by January 2027 as the administration implements new Section 301 tariffs. A Democratic Congress would bring more oversight of immigration enforcement and financial deregulation, but no major reversals of existing policy. A Democratic Senate will mainly slow confirmations, including for the Fed vacancy in January 2028, easing concerns over Fed independence. Escalation on tariff policy will remain a distinct area of risk for the next two years, while institutional friction risk between the executive and the legislative branches could cause additional volatility.
- Energy security is the key nexus between the midterms and inflation. A Democratic Congress will have limited ability to prevent a resumption of fighting with Iran in the near term. The main upside risk to oil and wholesale gas prices, and thus to our forecast of inflation and rates, is a resumption of military action against Iran. A brief escalation (given low US military stockpiles) could see oil prices peaking at around USD130/bbl (+15/20% vs current levels). However, all parties have an incentive to reach a deal. Greater congressional opposition under Democratic control could constrain the scale and duration of any further military action by freezing new funding, but not before January when the new Congress convenes. And the President could veto any bills that prohibit the use of appropriated funds for further offensive operations, or restrict funding for replenishing munitions used in those operations, thereby limiting the ability of Congress to prevent short-term military action.
- A renewed escalation would likely trigger an oil-driven inflation shock, leading to a bear flattening of the Treasury curve and a more hawkish Fed. Markets would be left repricing higher inflation at the same time as political instability and deteriorating fiscal dynamics increase Treasury volatility and the term premium, making political shocks more consequential than in previous episodes. Over a longer horizon, weakening growth, deteriorating household fundamentals and potential equity market weakness could support long-dated Treasuries through safe-haven demand. Rates volatility is likely to remain elevated, potentially prompting Treasury-led interventions to preserve market functioning.
- Risks for US equities are tilted to the downside. The S&P 500 has tracked past midterm years in which the President’s party lost a chamber, while credit has, as usual, been weak into the vote. Elevated yields limit multiple expansion, and tech is most exposed to AI-regulation headlines at the state level and renewed hostilities with Iran. The initial market reaction has been moderately negative, with tech-heavy Asian equity indices losing 3-4%, but later paring some of the losses. European markets opened positive and in the US, futures for the S&P 500 and Nasdaq also turned positive after an initial negative reaction. Some volatility in equity markets is expected but the results of the midterms should not cause strong corrections. From a sector perspective, healthcare looks best placed among defensives and energy offers a hedge.
- AI policy will likely stay light-touch in Washington, but the backlash is shifting the battle to the states and turning into a growth and investment risk. With new federal action unlikely, the leverage lies with states, which control permitting, siting and utility rates. According to our Allianz Pulse survey, 79% of Americans want AI regulation, and Gallup finds that 71% oppose data centers in their communities. This backlash already shifted the intentions of voters living near data centers towards the Democrats, who campaigned heavily on the issue, especially in swing districts. Local opposition blocked or delayed nearly USD200bn of projects in H1 2026, and New York has imposed the first statewide moratorium. The midterms have further increased this risk: Democrats won seven of the ten competitive governor races that will decide on 67 GW of planned capacity. Governors-elect who back a full or conditional moratorium now preside over 47 GW of planned data-center capacity, with three races still uncalled. A slower and costlier buildout would weigh on both growth and equity valuations.
Summary
Download full report
Authors
Pierpaolo Fiore
Allianz Investment Management SE
Simon Krause
Allianz Investment Management SE
Maximilian Bong-Maurer
Allianz Investment Management SE