Democrats winning the midterm elections sparked dramatic swings across global financial markets.
According to multiple mainstream US media projections, the Democratic Party scored a sweeping victory in the midterm elections held on November 3, regaining control of both the Senate and the House of Representatives.
US public opinion holds that this midterm election has "dramatically reshaped the power structure in Washington," leaving President Trump "facing a passive predicament of greatly diminished authority in the final two years of his term."
The election results triggered a "major shock" in US capital markets.
Over the two trading sessions on November 4 and 5, US stocks first rose and then fell.
As of the November 4 close, the Dow, the S&P 500, and the Nasdaq gained 3.03%, 1.58%, and 1.44% respectively.
As of the November 5 close, US stocks suffered a sharp selloff, with the Dow, the S&P 500, and the Nasdaq falling 3.44%, 4.36%, and 5.52% respectively.
The technology and industrial sectors bore the brunt of the decline, dropping 7.30% and 4.12% respectively on November 5.
International oil prices first plunged and then rebounded.
At the November 4 close, the December delivery light crude oil futures on the New York Mercantile Exchange fell 8.29%, while the January delivery London Brent crude oil futures dropped 8.67%.
At the November 5 close, those crude oil futures rose 2.72% and 3.88% respectively.
Throughout this process, the US dollar trended lower, declining 0.3% and 0.02% on November 4 and 5 respectively.
US Treasuries, by contrast, rallied, with the 10-year Treasury yield falling 6.8 and 5.9 basis points on November 4 and 5 respectively to around 4.83%.
Why would the Democrats regaining control of Congress cause such massive volatility in capital markets?
Analysts believe that with Democrats controlling Congress, the Trump administration may face more checks and balances in advancing fiscal, tax, and other policies going forward.
At the same time, the Democratic Party's stance on AI industry regulation and foreign policy could also influence the direction of the US economy and policy.
Looking further ahead, how will these changes affect the dollar and Treasury markets?
And will they alter the Federal Reserve's future interest rate decisions?
Dollar Weakens, Treasuries Strengthen
After Democrats won the midterm elections, the market began adjusting its expectations for US economic growth, fiscal spending, and inflation prospects, and both the dollar and Treasury markets—the pricing anchors for global currencies and financial assets—experienced volatility.
The dollar index fell steadily on November 4 and 5, at one point dropping to 101.21, a one-month low.
US Treasuries broadly rallied (with yields falling correspondingly), and the 10-year Treasury yield at one point declined to 4.814%, hitting its lowest level since September.
Regarding the performance of the dollar and Treasury markets, Bai Xue, Senior Deputy Director of the Research and Development Department at Orient Credit, said that earlier expectations of large-scale tax cuts and infrastructure spending under the Trump administration were important factors supporting dollar strength and rising Treasury yields.
With Democrats controlling Congress, it has become harder for the Trump administration to push a new round of tax cuts and expanded fiscal spending, and market concerns about further expansion of the US fiscal deficit and Treasury issuance have eased somewhat.
At the same time, the market worries that Democratic efforts to strengthen AI industry regulation could affect tech company investment and data center construction, thereby dragging on corporate capital expenditure and economic growth.
These changes have led the market to lower its expectations for US economic growth and for the Fed to maintain high interest rates, narrowing the interest rate differential between US Treasuries and non-dollar currencies, reducing the dollar's appeal, and pushing Treasury yields lower as well.
Hu Jie, a professor at the Shanghai Advanced Institute of Finance at Shanghai Jiao Tong University and a former senior economist at the Federal Reserve, told reporters that the dollar's short-term weakness is mainly due to increased market uncertainty from the political shift, with some investors choosing to temporarily withdraw from related assets and hold cash on the sidelines.
The decline in Treasury yields is related to the market's adjustment of expectations for US fiscal spending expansion.
Democrats and Republicans checking each other could make it harder to pass large-scale fiscal spending bills, limiting further government spending increases and thereby marginally easing the supply pressure from Treasury issuance.
Jim Reid, Global Head of Macro Research at Deutsche Bank, also believes that "given that divided government typically makes fiscal stimulus harder to pass, US Treasury prices have risen accordingly. This has somewhat eased concerns about the direction of fiscal policy."
He also said investors expect the Fed to take a more dovish policy path, with market expectations for a Fed rate hike in June 2027 declining, which has also pushed the dollar index lower.
AI industry regulation is another thread the market is watching.
"Democrats had previously been relatively cautious about building large numbers of data centers. During the election campaign, Democrats made related issues one of their talking points for criticizing Trump's policies. Therefore, after gaining more congressional power, Democrats may continue to take a relatively prudent attitude toward the development of the US AI industry. If Democratic policies impose certain constraints on the AI industry, the sector's demand for capital may weaken in the future, thereby easing the competition for funds between it and the Treasury market," Hu Jie said.
Stephen Brown, Chief North America Economist at Capital Economics, said that with Democrats controlling Congress, the likelihood of future increases in corporate taxes and AI industry regulation has risen.
Previously, some Democratic candidates had expressed regulatory demands regarding data center construction and its energy consumption.
In addition, changes in AI industry investment could also affect US inflation through energy costs.
Yang Zirong, Deputy Director and Associate Researcher of the Global Macro Division at the Institute of World Economics and Politics under the Chinese Academy of Social Sciences, believes that if stricter AI industry regulation leads to a slowdown in data center construction and related capital expenditure, the cost pressure from rising electricity demand could also ease at the margin, thereby reducing inflation pressure.
This change could affect the market's assessment of the Fed's subsequent rate path.
"However, the above factors are not yet sufficient to mean that Treasury yields will enter a trend decline. Long-term Treasury yields are influenced not only by market expectations for the Fed's policy rate but also by factors such as term premiums. Even if the market lowers yields due to cooling fiscal expansion expectations, if term premiums remain at a high level, long-end Treasury yields could still face upward pressure," Yang Zirong added.
Inflation Expectations and Oil Price Changes: Will Fed Policy Shift?
"A pullback in fiscal expansion will suppress additional upside in aggregate demand and reduce demand-pull inflation momentum; easing in the Iran situation driving oil prices lower directly relieves energy-related imported inflation pressure. The two combined will accelerate the pace of inflation falling back toward target and reduce the need for the Fed to maintain high interest rates," Bai Xue said.
After the midterm elections, international oil prices fell sharply.
The market expects that with Democrats controlling Congress, the Trump administration may face more political and fiscal constraints in continuing military action against Iran.
Dennis Kissler, Senior Vice President and Head of Trading at US financial services firm BOK Financial, said: "Democratic control of Congress could tighten US military spending in the Middle East and further raise the possibility of an early peace agreement."
He noted that increased Middle East crude oil exports and Trump's statement that there are currently no plans to strike Iran have both intensified downward pressure on crude oil prices.
Hu Jie also believes that if Democratic control of Congress constrains Trump administration policies and thereby affects US foreign military operations and energy markets, it could theoretically have an indirect impact on inflation.
"However, this transmission chain is long, and it will be difficult to directly reflect it in changes to Fed monetary policy in the short term. In addition, even if the relevant military conflict ends, oil prices and inflation will not immediately return to normal and will still require some time for transmission and adjustment," Hu Jie said.
Regarding the Fed's subsequent policy, he believes there is still a relatively high probability that the Fed will hike rates in December this year.
Whether it continues to hike next year will require observing subsequent economic data.
If the economy and inflation improve, further hikes may not be needed next year, but rate cuts may not come until at least mid-next year.
Yang Zirong also believes that the Fed's rate path in 2027 will be affected by energy price trends.
He said that if oil prices only spike briefly and then fall back, and inflation expectations remain stable, the Fed will most likely be able to begin gradual rate cuts in 2027; but if geopolitical conflict keeps energy prices elevated for a long time and further transmits to core inflation and wage growth, the Fed may be forced to maintain restrictive interest rates for longer, and a reversal in monetary policy cannot be ruled out.
Daleep Singh, Chief Global Economist at US firm PGIM, offered a different judgment.
He believes that the Democrats' landslide victory in this midterm election may instead create room for the Fed to further tighten monetary policy.
Singh argues that the election results weakened Trump's influence over Congress, US politics, and the Fed, giving the Fed greater freedom in implementing monetary tightening.
He expects the Fed may hike rates four more times by the end of 2027, by 25 basis points each time, pushing the federal funds rate target range up to 4.75% to 5.00%.
Based on current market pricing, the election results have not yet significantly changed investors' judgment on the Fed's short-term policy.
As of press time, CME FedWatch data shows the market still expects more than a 70% probability that the Fed will raise rates by 25 basis points in December.
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