A change in congressional control alone is unlikely to reverse the deficit and interest-rate outlook; inflation, growth, and earnings remain more durable market variables.
As the U.S. midterm elections approach, the core questions on investors' minds are becoming clearer: Will cost-of-living pressures change the election outcome? And how will a change in congressional control affect fiscal spending, regulation, and the markets?
Monica Guerra, head of U.S. policy and geopolitics strategy at Morgan Stanley Wealth Management, recently visited more than 25 cities across 13 U.S. states and Washington, D.C., to discuss these issues with clients. Her core judgment: the election will likely reshape Washington's political landscape, but may not change the investment outlook to the same degree.
Under divided government — where the president's party does not control both chambers of Congress — executive actions and regulatory changes could still drive share-price swings in some sectors. However, inflation, economic growth, and corporate earnings are expected to remain the main factors determining broad market performance.
I. What has changed in the House and Senate races?
Morgan Stanley continues to expect Democrats to retake the House. According to its October 27 estimate, Democrats need a net gain of just three seats to reach the 218-seat majority threshold.
The Senate call has changed in recent weeks: it previously expected Republicans to hold the majority, but now sees the two sides as evenly matched, with Democrats slightly favored.
Cost-of-living pressures and weakening consumer confidence are weighing on the party in power, making the Senate races more competitive. However, Democrats still need a net gain of four seats in the 100-seat Senate to take control. Republicans' campaign resources and the specific circumstances of individual districts may also limit Democratic seat gains.
If Democrats win the House as expected, regardless of which party controls the Senate, divided government will take shape. At that point, the difficulty of advancing large-scale legislative reform will rise markedly.
II. Is divided government good for markets?
Divided government often provides some support for markets, because political gridlock reduces the likelihood of major changes in tax, regulatory, and government spending policies.
Historical data cited by Morgan Stanley shows that during Republican presidential administrations, if Democrats controlled both chambers of Congress after midterm elections, the S&P 500 rose an average of about 16% in the following calendar year; if the two chambers were controlled by different parties, the average gain was about 23%.
But historical performance cannot guarantee future returns, and these averages cannot be used directly as forecasts for the current market cycle.
As of the report's publication, U.S. stocks' 2026 performance was already better than the typical level in the second year of a presidential term, potentially front-loading some of the post-election upside. This is especially true for the technology and energy sectors, which have already posted sizable gains this year.
Even if companies' long-term earnings prospects remain unchanged, news that regulatory scrutiny or government support may decrease could trigger stock pullbacks. Morgan Stanley judges that when the market's reaction to policy news exceeds the potential impact on companies' actual operations, some of the adjustment may present selective investment opportunities.
III. Can political gridlock eliminate policy uncertainty?
No. The president can still adjust policy through executive authority, and federal agencies can also change regulatory approaches. Even if relevant bills ultimately fail to pass, congressional hearings, investigations, and policy proposals themselves may trigger stock price volatility.
The key to judging the significance of these developments is whether they will change corporate costs and earnings prospects, or merely cause short-term price fluctuations.
However, congressional gridlock does significantly compress the room for major legislation. Major bills involving government funding or corporate costs become harder to enact, and the likelihood that such legislation will continuously change business performance also declines accordingly.
IV. How will resistance to data centers affect AI-related stocks?
Growing local opposition to data centers may delay some projects and trigger short-term volatility in AI infrastructure-related stocks, but it may not necessarily weaken these companies' long-term prospects.
For example, state or local government moratoriums on data center development may slow project construction; at the same time, they may also push developers to reach agreements with localities to increase grid upgrades and other infrastructure investment in response to residents' concerns about rising electricity bills.
V. Will the End of the Iran War Affect the Election Outcome?
According to Morgan Stanley's assessment on October 27, the likelihood that the Iran war will end before the November 3 vote is becoming increasingly low.
Even if the conflict ends by then, high energy costs and broader price pressures will be difficult to ease quickly, and may not come in time to sufficiently improve voter sentiment and thereby affect the election outcome.
Morgan Stanley research estimates that after the Strait of Hormuz reopens, lost production in the Middle East may still need about four months to recover 75%, with full recovery potentially extending to later in 2027.
During this period, logistics and technical bottlenecks may continue to constrain oil and fuel supplies, slowing the pace at which energy costs decline for households and businesses.
VI. Will the Midterm Elections Change the Debt and Interest Rate Outlook?
Election results alone are unlikely to significantly change the long-term outlook for U.S. interest rates or the fiscal deficit. The fiscal deficit refers to the gap between government spending and revenue, which must be covered through borrowing and other means.
Large-scale government borrowing and Treasury issuance tend to put upward pressure on bond yields and weigh on asset prices. All else being equal, rising bond yields mean falling prices for existing bonds.
Spending cuts can moderately reduce borrowing needs, but substantially narrowing the fiscal gap requires broader tax and spending reforms. Under a divided government, such reforms are expected to be difficult to advance.
Therefore, a change in congressional control may not necessarily bring significantly lower interest rates, nor necessarily provide lasting support for the bond market.
VII. Will a Delayed Election Outcome Shock the Markets?
A close race or delayed vote count may trigger short-term volatility, but the delay itself is unlikely to change the long-term drivers of the market.
Historically, contested House and Senate elections have had relatively limited impact on markets. If election integrity or electoral procedures face broader shocks, greater turbulence could result.
For investors, inflation, economic growth, and corporate earnings are expected to have a more lasting impact on markets than when election results are revealed.
Changes in congressional control affect fiscal spending, regulatory oversight, and legislative priorities. But what ultimately determines overall U.S. stock market performance is still more a function of the economic cycle and whether companies can convert growth into profits.
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