- Democrats seize control of Congress as Iran war crushes Republicans.
- A legislative gridlock or a Democratic agenda?
- Dollar risks losing its shine, but gold could restore its crown.
- But AI and cryptos might be biggest losers.
A big thumbs down
The 2026 U.S. midterm elections delivered a decisive shift in Washington, with Democrats achieving a resounding victory over the Republican Party. Voters overwhelmingly rejected President Trump’s policies, especially his aggressive stance on Iran.
Soaring energy costs and broader price increases from the ‘Liberation Day’ tariffs have eroded President Trump’s popularity, impacting the Republican Party in pivotal states that were previously considered Republican strongholds.
It is ironic that the very economic pressures that fueled Trump’s 2024 landslide victory—the high cost of living—have now driven voters to abandon the Republican Party in this week’s midterms. The magnitude of Republican losses exceeded even the most optimistic Democratic projections, securing a decisive majority in both chambers of Congress for Trump’s remaining two years.
Lame duck Trump
Lame duck presidencies are not necessarily the worst outcome for financial markets, and are often the preferred scenario when Congress is divided, limiting the legislative agendas of both parties. However, with a significant Democratic victory sweeping Capitol Hill, investors are concerned about the implications for the U.S. economy. Despite ongoing tariff disputes and an energy crisis, the economy has benefited from Republican-led tax cuts and deregulation.
While the President retains veto power over major legislation and Democrats will need to negotiate with Republicans on certain matters, the balance of power has shifted toward the Democratic Party. With majorities in both chambers, Democrats can pursue policy changes including increasing the corporate tax rate, restoring expired Affordable Care Act subsidies to boost health care spending, and reintroducing tax credits for renewable energy to reverse some of Trump’s climate policies.
Nevertheless, Democrats are likely to secure approval for their major priorities only by making concessions to Republicans, especially regarding Medicare. Despite their historic electoral success, the midterms have ushered in a new era of divided government for the next two years.
Good for bonds
For financial markets, the primary concern is the impact on U.S. Treasuries, given persistent worries about the nation’s growing debt burden. The Iran conflict has driven up energy prices, reviving inflation and prompting expectations of further rate hikes.
Bond markets experienced their worst downturn in years in September, pushing long-term borrowing costs to levels not seen since 2002. Amid rising inflation and a surge in debt issuance from both government and corporate entities, high yields have triggered volatility across foreign exchange, equity, and commodity markets. However, the U.S. dollar, as the global reserve currency, remained resilient and benefited from its safe-haven status.
With Democrats controlling Congress, the Trump administration will face significant challenges in advancing tax incentives beyond the ‘Big Beautiful Bill.’ Simultaneously, Democrats will be constrained from excessive spending increases.
Fiscal negotiations
Treasury yields have fallen following the election results, as legislative gridlock reduces the risk of the budget deficit spiraling further. Additionally, raising the debt ceiling—likely required in early 2027—will be simpler with unified Democratic control of Congress.
However, negotiations on passing the critical funding bill by December 11, before newly elected members take office, are expected to be contentious, potentially leading to a government shutdown unless lawmakers agree to a temporary funding measure to avoid a shutdown.
Bad for growth?
However, the improved fiscal outlook is only part of the story; increased regulatory pressure on businesses, particularly in the AI sector, could dampen economic activity and slow growth, which may further suppress Treasury yields.
This could significantly slow AI investment growth. Even without federal AI regulation, Democrat-led states may curb the datacentre expansion boom, intensifying concerns about AI demand.
This represents the most significant downside risk for the U.S. dollar and Wall Street. However, the impact on U.S. equities is nuanced: a cooling economy driven by reduced AI spending may lessen the need for aggressive Fed rate hikes, as policymakers adopt a more cautious approach, which would please Wall Street traders.
This trend is already evident, with major technology stocks benefiting from a more favorable interest rate trajectory and potential reductions in AI-related costs, while semiconductor manufacturers face ongoing challenges due to weakened demand for chips stemming from restrictions on AI datacentres.
Hopes for Iran ceasefire
A further dimension to the inflation outlook stems from the Iran conflict: Trump’s Middle East activities have been deeply unpopular with American voters, contributing to rising gasoline and diesel prices. While the President ultimately determines military actions, Democrats may threaten to reduce defense spending if Trump orders new strikes against Iran. With Republicans also acknowledging that the war hurt their electoral prospects, they may align with Democrats if Trump does not withdraw soon.
The primary concern is Iran escalating and forcing a defensive response. Otherwise, investors anticipate a swift resolution to the conflict, as evidenced by the recent sharp decline in oil prices. Additionally, the Federal Reserve is not expected to raise rates more than twice in the next 12 months, which could stabilize AI-related stock declines and support small-cap and value equities.
The healthcare and financial sectors are expected to benefit from a Democratic majority, while defense and energy stocks are likely to underperform.
Dollar risks
However, a shallower rate path is negative for the dollar, though reduced trade tensions may offer some upside. Congress has limited power to repeal existing tariffs, as overriding the President’s veto would require a two-thirds majority in both chambers. Nonetheless, lawmakers may seek to exempt certain products from tariffs or constrain the President’s trade policy authority.
Overall, with Trump losing congressional control, he is less likely to escalate his trade war. Prior to his defeat, surprise progress emerged in negotiations with Canada to establish a new trade agreement.
Changing fortunes for Gold?
Lower yields, a weaker dollar, and cheaper oil create an ideal environment for bullish gold. The optimal scenario involves Trump resolving the Middle East conflict and oil prices declining, but even without that, the shifting U.S. political landscape provides robust support for the precious metal.
This may not be a perfect scenario, but reduced fiscal risks should cap Treasury yields even if energy prices remain high. Economic growth may also slow due to anticipated AI rollout challenges, moderating Fed rate hikes. However, a sustained downturn in AI stocks could dampen gold prices as investors sell bullion to cover equity losses or margin calls.
CLARITY Act may not be dead
Legislatively, Democrats are certain to leverage their new authority to investigate Trump’s family business dealings, though these probes are unlikely to significantly impact markets. More importantly, they aim to amend the CLARITY Act to impose stricter restrictions on cryptocurrency transactions by the president and his family, enhance consumer safeguards, and strengthen enforcement and anti-money laundering provisions.
While major cryptocurrencies like Bitcoin and Ether would still see positive effects from the bill’s passage, as it achieves its goal of regulatory clarity, the gains would be significantly less than if the legislation had passed earlier. A congressional decision to delay the bill indefinitely would likely push cryptocurrencies into a downturn until at least 2028.
A storm before the calm?
The full impact of a Democratic-led Congress on markets will likely become clear only a few months into the new term, when party leaders outline their agenda. Democrats may face a challenging start if Republicans trigger a government shutdown before the holidays or if Trump orders a final major military strike on Iran before any ceasefire agreement is reached.
Investors should find reassurance that the Trump administration lacks strong support for new Iran strikes, potentially making it difficult for Trump to act unilaterally. Additionally, it is uncertain whether Democrats will sustain their opposition to AI datacentres if Wall Street panic intensifies and job cuts rise in states resistant to the AI buildout.