US midterm results signal political uncertainty for global markets and inflation

The loss of control of both the House of Representatives and the Senate by the Republican party has placed the global economy on alert for an unpredictable final two years of Donald Trump’s presidential term. Following the Democratic sweep in the midterm elections, analysts have indicated that the prospect of a highly erratic lame-duck president carries significant implications for financial markets, economic growth, inflation, government borrowing costs and living standards. The outcome is expected to influence stock markets, interest rates and the broader economic trajectory in the United States and internationally.

Initial market reactions were mixed, with indices dropping in early Asian trading before rallying as investors assessed the results. While investors generally dislike uncertainty and political chaos, the president’s concession of the result and his acknowledgement of the impact of the Iran war were viewed positively. However, his warning that he intends to become “Mr Veto” has raised concerns about a turbulent conclusion to his time in the White House. Holger Schmieding, chief economist at Berenberg, noted that the result demonstrated that US voters had rejected Trump and his authoritarian penchant for crony capitalism. He argued that this outcome shows US institutions and checks and balances are functioning, which he considers a positive development.

The outlook for stock markets, inflation and growth remains heavily contingent on the war in the Middle East and the pace of artificial intelligence advancement. Traders anticipate that Democrats will adopt a tougher line on AI regulation and datacentre rollout, raising questions about a key driver of stock market growth. There are also concerns that, with his control over domestic policy weakened, Trump may take a more aggressive approach to foreign policy, potentially intensifying the conflict in Iran. The cost to US households from surging inflation, triggered by the unpopular war and a chaotic tariff policy that has devastated small businesses, was a key factor in the midterm result. US diesel prices reached a record high in August, while the headline inflation rate has risen to 3.7%.

The US-Israeli invasion of Iran and the subsequent closure of the critical strait of Hormuz have reignited global inflationary pressures amid a significant energy price shock. Oil prices fell back on Wednesday, dropping by as much as 9% to trade below $100 a barrel for the first time in a month, as investors digested the results amid hopes for a diplomatic breakthrough. Brent crude, the international benchmark, remains significantly higher than its prewar level of about $70. Consequently, the International Monetary Fund expects global headline inflation to rise to 4.7% this year, with energy-importing countries hardest hit. The possibility of Trump ramping up hostilities against Iran would add to this inflationary shock, though it would also further increase his unpopularity.

Higher inflation has forced central banks to raise interest rates. The US Federal Reserve defied pressure from Trump by increasing the cost of borrowing for the first time since 2023. Against a volatile backdrop, investors anticipate at least one more rate increase from the Fed. The Bank of England is expected to raise rates on Thursday, while the European Central Bank is also expected to push up borrowing costs. With the Republicans lacking the votes to confirm new appointments to critical public bodies, including new Fed governors, Trump could still use his veto powers, which can only be overturned if two-thirds of both chambers agree.

The logjammed political system faces its first major test on 11 December, when politicians must agree to authorise government spending to avoid a shutdown. This gridlock could prevent Trump from launching new tax and spending measures, restricting the capacity for fiscal stimulus while also limiting a further rise in borrowing and debt. Analysts suggest that the crushing midterm defeats for MAGA candidates will hurt the president’s authority and could pave the way for more cooperation between Republicans and Democrats in Congress. While political turbulence and presidential actions on trade and immigration could put US growth at risk, inflation and the prospects for de-escalation in the Middle East remain the main factors to watch.

Investors are wary that a clampdown by Democrats on AI could hit investment and growth in the US, with spillovers from the tech boom having bolstered the UK economy. However, tech industry leaders were already cooling on the rollout of AI amid concerns over cyber risks, and many investors feared the emergence of a bubble in the US stock market. Analysts at Allianz note that the scale of AI investment could make the left-right political playbook less predictable than in the past. As recently as last month, the IMF forecast that US growth would remain stable at 2.3% this year and next, despite heightened risks from the Iran war and uncertain AI investment paths. Conversely, analysts at Berenberg said US growth could slow to about 1.5% in 2028 amid political gridlock, a slowdown over AI and a drag from Trump’s crackdown on immigration, resulting in a smaller contribution to global growth.