“Blue wave” sweeps Democrats to power
The Democrats swept to power in the 2026 US mid-term elections, gaining larger than expected majorities in the House and Senate. The Democrats gaining a majority in Congress will block any new sweeping domestic policies from President Donald Trump but is unlikely to block Trump’s trade and international policy activism.
Domestic policy gridlock limits economic impact
The results of the mid-terms are unlikely to have a lasting impact on the US economy. Domestic policy inertia is the most likely result. Trump has veto power over any major policy initiatives put forth by the Democrats and the Democrats will likely have the votes to block any major tax cuts or other initiatives from the Trump administration. While at the margin this is positive for the US government bond market and negative for the US dollar on lower US bond yields, other factors are likely to remain the key driver of the macro and market outlook.
Iran war and energy prices are key to economic and market outlook
What matters most in the near term is how the war with Iran evolves and its impact on energy prices, inflation and growth. Trump will still have primary control over this area. The longer energy prices stay high, the greater the risk the US Federal Reserve makes a policy mistake. And the greater the likelihood of an economic and earnings slowdown in 2027, as consumers pull back and companies have trouble passing on higher input costs.
Slower growth, modest tightening cycle
Although high energy prices are likely to keep rates higher for longer and weaken economic growth in 2027, the risks of deep and prolonged slowdown are relatively low because:
- Major developed economies have become far less energy intensive and far less dependent on fossil fuels in the energy mix in recent years, and
- Still strong aggregate household, corporate and bank balance sheets provide shock absorbers most major economies they didn’t have in 2008, during the Global Financial Crisis (GFC).
While there is a risk central banks overtighten, the current central bank tightening cycle will likely be relatively short-lived and modest compared to the 2022 tightening episode, with balanced-to-loose labour markets in most countries (relative to 2022) keeping wage-price spiral inflation risks much lower, interest rates at a much higher starting point and quantitative easing (QE) programmes halted or reversed.
Rising government debt biggest medium term risk
One of the biggest underappreciated (or recently ignored) medium term risks to the outlook is the continued huge US fiscal and growing government debt burden. With US interest payments now making up around 20% of government revenues – more than any other major developed economy – Treasury Secretary Scott Bessent’s adjustments to government debt issuance and purchase schedules are band-aids on a structural problem that will only be solved by reining in the fiscal deficit. With little apparent appetite from the Trump administration (or Congress) to tackle the deficit, in the background of the day-to-day macro and micro news, the risk of turmoil in the US bond market is rising.
Strong balance sheets limit downside risks, but idosyncratic risks on the rise
Economic growth and earnings have held up well in public and private markets so far this year. Excluding AI investment, US growth is trending around 1.5% on our estimates, similar to growth in Europe, with earnings in both regions holding up well. Although growth is likely to slow in 2027 and rates are likely to only gradually come down later in 2027, the structural underpinnings of major economies are still sound, with private sector balance sheets broadly in decent shape. Within the broad aggregates there is, however, wide dispersion. With interest rates and energy prices likely to remain elevated, households and corporates with weaker balance sheets are likely to come under increasing pressure. Therefore, while systemic risks still look low, idiosyncratic risks are likely to continue to rise.
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