How might the 2026 US midterms influence financial markets?

The US midterm elections will be held on Tuesday, November 3. The outcome of these elections will determine how much legislative room President Donald Trump has during the final two years of his term.

Any change in congressional control could potentially trigger a more aggressive ‘lame-duck’ session - the period between election day and the sitting of the next Congress on January 3, 2027.

History is firmly against the president's party. In the 23 midterm elections from 1934 to 2022, the president's party lost House of Representatives (House) seats 87% of the time and Senate seats 65% of the time.¹ This translates to an average loss of 27 House seats and three Senate seats, largely reflecting turnout dynamics. Opposition supporters are usually more motivated to vote than the president’s supporters while swing voters often seek to curb the party in power.

House race

Current split: 218 Republicans, 214 Democrats, 1 independent, 2 vacant.

All 435 House seats are contested, with 218 seats needed for a majority. The Cook Political Report rates 21 House seats as likely toss-ups with Democrats needing a net gain of four seats to take control of the House. The Generic congressional vote shows Democrats have averaged a roughly six point lead in the past three months putting them around the historical range typically associated with winning the House. 

Senate race

Current split: 53 Republicans, 45 Democrats, 2 independents that caucus with Democrats.

35 of the 100 Senate seats are up for election. It takes 51 seats or 50 seats plus the vice presidency for a majority. The Cook Political report currently rates six Senate seats as toss-ups (Alaska, Iowa, Maine, Michigan, Ohio, and Texas) with Democrats needing a net gain of four seats to flip the Senate.

The electoral map is challenging for the Democrats as they must not only defend the toss-up in Michigan but also pick-up four Republican-held seats to secure an outright majority. That’s within reach as Polymarket odds of the Democratic Party controlling the Senate surged in September from a low near 50% to as much as 65%. Still, Democrats are hardly riding a wave of affection, with a favorability rating on par with Trump’s (Chart 1).

Gridlock with blue risks

Our base case scenario is a Democratic House and Republican Senate, although the tide has turned towards Democrats taking both chambers. A divided government would constrain President Trump’s tax and spend agenda. Trade, foreign policy, regulation, and executive action would remain largely under White House control, while a Republican Senate would preserve President Trump’s ability to confirm judges, and other senior officials like Fed governors.

If Republicans lose both chambers, a scenario that is no longer a long shot, the Trump administration would face greater congressional oversight, while a Democratic Senate would block Trump’s nominees to the Fed, judiciary, and regulatory agencies.

Reconciliation 3.0

The next fiscal catalyst is already in view. On July 22, the House passed a fiscal year 2027 budget resolution centered largely on military spending dubbed the ‘SAVE and Protect America Act’ or commonly referred to as ‘Reconciliation 3.0’. This would be the third budget resolution under the current Trump administration following the 2026 ‘Secure America Act’ and the 2025 ‘One Big Beautiful Bill Act’ (OBBBA).

September and October will be the critical window for getting Reconciliation 3.0 through Congress and on President Trump’s desk before the November 3 midterms. The timetable is tight given that House and Senate Republicans still need to agree on the package’s size and composition. Any delay would likely push its passage into the lame-duck session, when the current 119^th Congress remains in place until January 3 and the incentive to front-load unfinished fiscal priorities could become stronger if Republicans lose control of Congress.

The House Republican blueprint for Reconciliation 3.0 allows up to $95 billion of primary deficit increases over the 2027-2036 period. The package could end up being larger if Congress moves closer to the President’s $350 billion defense funding request. That would still be a fraction of the $3.4 trillion OBBBA but larger than the $69.5 billion Secure America Act.

If reconciliation 3.0 moves closer to the President’s $350 billion request, the Congressional Budget Office estimates the funding would add roughly 0.3% of GDP to federal spending at its peak in 2028 and 2029 before fading sharply thereafter.

As such, the fiscal impulse is negligible, with the broader fiscal stance still expected to remain a modest drag on growth over the next couple of years (Chart 2). That won’t shift the dial on Fed funds rate expectations but at the margin skews the risk in favor of a dovish Fed repricing, which would be a cyclical headwind for the US dollar.

A trip down memory lane

The four midterm election scenarios outlined below each have a historical parallel, with one notable exception. The main lesson is that political gridlock does not always translate into fiscal gridlock. The interaction with Fed policy and the US balance of payments ultimately shaped the direction of the dollar and stocks.

1. Republicans hold the Senate. Democrats flip the House. This would echo the 2018 midterms characterized as the “blue wave” election. Over 2019, both fiscal and monetary policy loosened (Chart 3), supporting a nearly 30% gain in the S&P500 while the dollar was mixed (Chart 4).

2. Republicans retain Congress. The closest precedent is 2002, when the post-9/11 “rally around the flag” effect helped President George W. Bush’s party defy the usual midterm losses. Over 2003, fiscal policy loosened sharply while the Fed delivered a final 25bps cut to 1.00% (Chart 3). The S&P 500 gained over 26% by the end of 2003 (Chart 4), while low rates and a widening twin deficit (current account and budget balance) dragged the dollar lower (Chart 5).

3. Democrats flip Congress. This would resemble 2006, when Democrats took both chambers amid mounting opposition to the Iraq war. Over 2007, fiscal policy loosened while the Fed slashed rates by 100bps as housing and credit strains intensified (Chart 3). The S&P500 extended its post dot com bull market with a modest 3.5% gain by end-2007 before the global financial crisis sent stocks tumbling (Chart 4). Meanwhile, the widening US twin deficit helped drag the dollar to fresh lows (Chart 5).

4. Republicans keep control of House and Democrats flip the Senate. Polls suggest this scenario is highly unlikely, and historically unprecedented at a midterm under a Republican president.

Beyond the midterms

Regardless of the midterm outcome, the US fiscal trajectory will not improve. Under current policies, the Congressional Budget Office (CBO) projects the primary budget deficit (overall budget balance excluding interest expense) to average -2.1% over the next ten years, pushing public debt to a record 120% of GDP by 2036.²

Perversely, rising US public sector borrowing is helping to offset the demand drag from household deleveraging and sustain private consumption (Chart 6). But the support comes at a cost. Rising interest expense and heavier Treasury issuance are poised to lift the term premium, the compensation investors require for holding long-dated Treasuries (Chart 7). If higher yields increasingly reflect fiscal risk rather than stronger US growth, a structurally weaker dollar could become the relief valve to worsening US fiscal credibility.

Q4 event risk watch

The US midterms are not the only political event risk in Q4. Several other key flashpoints could stir markets.

• France 2027 budget on October 6. A rollover of the 2026 budget is the most likely outcome given the limited appetite for compromise before the presidential election on April 18, 2027. That could push the deficit from around 5.1% of GDP in 2026 to roughly 6.0% in 2027, taking France further away from its European Commission commitment to bring it below 3% by 2029. Regardless, France’s worsening fiscal credibility remains country-specific and not systemic as Eurozone periphery bond yields spreads to Germany are contained, limiting the drag on EUR (Chart 8).

• Brazil presidential and congressional elections. First round on October 4 with a likely runoff on October 25. Incumbent leftist President Luiz Inácio Lula da Silva of the Workers’ Party (PT) and rightist Senator Flávio Bolsonaro of the Liberal Party (PL) are locked in a dead heat in a runoff scenario.

Bolsonaro’s plan for faster fiscal repair and lower taxes would add to the positive BRL outlook, already underpinned by Brazil’s attractive carry and strategic exposure to commodities linked to energy, AI, and defense. Meanwhile, Lula’s greater tolerance for rising debt will likely slow the appreciation in BRL. Brazil’s gross public debt has risen from 71.7% of GDP when Lula took office in January 2023 to 82.5% of GDP in July 2026, the highest since 2021 (Chart 9).

• Israel legislative election on October 27. A party bloc requires 61 of the 120-seat Knesset to form a stable government. Polls show both the Netanyahu bloc and the anti-Netanyahu bloc led by Gadi Eisenkot falling short of a majority. However, the Eisenkot camp could cross the 61 seats threshold with support from the Arab parties.

A Netanyahu bloc victory would revive the judicial overhaul, raising concerns about the rule of law and political stability, and weigh on ILS. A centrist government would likely reduce institutional and geopolitical risk and support ILS.

• UK Autumn Budget on October 28. UK Chancellor John Healey has pledge to build a solid fiscal “buffer against uncertainty” in the Budget. That points to a mix of tax rises and spending cuts as higher borrowing costs are estimated to have halved the government’s fiscal headroom to around £12bn. The prospect of tighter UK fiscal policy, leaves GBP vulnerable to a dovish repricing in Bank of England rate hike expectations (Chart 10).

• Japan extraordinary Diet session in early October and 2027 Budget approval in late December. The Diet session will focus on the proposal to cut the food consumption tax rate from 8% to 1% for two years from April 2027 and how the government will cover the estimated ¥4 trillion annual revenue shortfall.

Meanwhile, Ministries have requested a record ¥143.1 trillion (21% of GDP) for the fiscal year starting in April 2027, while the government aims to cap new JGB issuance below ¥40 trillion. Breaching the ¥40 trillion cap would deepen fiscal concern and undermine JPY. If it holds, Japan’s favorable currency mix of loose fiscal policy (Chart 11) and tight monetary policy would bode well for JPY.