According to a report from Zhitong Finance APP, Morgan Stanley noted in its latest research report that Democrats have won control of both the House and Senate, although some election results are still being counted. This decisive election outcome indicates the situation is developing toward what the bank envisioned as a "Democrats cohesive majority" scenario. Under this scenario, uncertainty brought by a change in governing power could become a headwind for overall stock market performance, with effects similar to the market volatility triggered after Republicans newly took control of the House following the 2022 midterm elections. However, cuts to SNAP (Supplemental Nutrition Assistance Program) and Medicaid may be delayed in implementation, which would benefit consumer-facing sectors and create some upside risk to economic growth forecasts.
Morgan Stanley stated that the path for either party to advance budget reconciliation bills along party lines has now closed, removing the main upward risk to U.S. Treasury financing needs. Although delaying cuts to SNAP and Medicaid spending would have the opposite effect, its impact may be relatively small compared with the $2 trillion fiscal deficit. The key policy battle is more likely to focus on the short term, because the Democratic majority can build consensus around policy demands and use the December government funding deadline and the 2027 debt ceiling issue as negotiating leverage.
In terms of major market impacts, AI market sentiment could be further negatively affected as expectations rise for data center restrictions. However, Morgan Stanley believes the additional adverse effects will be region-specific and will not change the overall narrative of AI capital expenditure development. Its base case assumes AI-related capital expenditure will remain stable. At the same time, Morgan Stanley's overall outlook for resilient economic growth and a continued slow decline in inflation remains intact.
In foreign exchange markets, Morgan Stanley expects short-term trading to remain consistent with its defensive market scenario, namely stronger performance of the Japanese yen, Swiss franc, and euro against the U.S. dollar. AI-related headwinds could cause the Australian dollar to lag in cross rates, while targeted tariff risks could weigh on the Canadian dollar relative to low-yield currencies. Increased congressional resistance to another escalation of geopolitical conflict could also put downward pressure on the Norwegian krone/Swedish krona exchange rate.
The likely policy path requires focus on four areas:
1. Fiscal policy. Morgan Stanley expects that measures in the One Big Beautiful Bill Act (OBBBA) related to cutting SNAP and Medicaid spending may be repealed, delayed, or loosened during negotiations over fiscal policy deadlines. Democrats are likely to have a sufficiently large majority both to reconcile differing views within their caucus and to build consensus around a small number of policy goals. Overall, however, even if these cuts are delayed, the bank still believes the U.S. fiscal deficit will remain around 6% of GDP.
2. Executive-led policy. Morgan Stanley believes that since the start of President Trump's second term, policy uncertainty has mainly been related to executive branch actions rather than legislative actions. Policies on tariffs, geopolitics, trade (especially the USMCA review), deregulation, and export controls are all expected to continue, so policy uncertainty should be expected to remain at a certain level.
3. Data center restrictions. Morgan Stanley believes the real risk is that state-level rules pushed by newly elected officials could further fragment the United States, making some regions open to new data center construction while others do not allow such projects to proceed. The key levers that can truly constrain projects, including grid interconnection, large-load electricity pricing design, site selection, and tax incentives, are almost entirely controlled by state regulatory commissions, state legislatures, and county commissions. Therefore, power transitions in some governorships deserve close attention, although the related effects may be limited to specific jurisdictions.
From the perspective of data center development, the most important result in this election is undoubtedly the Texas gubernatorial election. In Texas, Democrat Gina Hinojosa was elected governor, increasing policy risk regarding data center approvals and construction timelines. Gina Hinojosa's campaign platform included a moratorium on approving new data center projects. Considering that the Texas governor can participate in approvals for new data center projects through multiple regulatory bodies, Morgan Stanley believes many projects may face significant delay risk.
4. Signals for the 2028 election. Morgan Stanley has consistently argued that midterm election results should not be directly extrapolated to the 2028 presidential election. However, the next two years will be a window for lawmakers to lay the groundwork for federal policy action in 2029 and beyond, provided control of the presidency ultimately changes by then. Morgan Stanley believes lawmakers may propose legislation targeting AI infrastructure construction, such as repealing the immediate expensing policy in OBBBA or imposing a tax on computing power. But given the president's opposition to such measures, these bills are unlikely to actually be enacted.
Major Market and Economic Implications
U.S. equities. As Morgan Stanley discussed in last week's report, the midterm election was the most obvious risk event and has now passed, while historical performance also provides encouraging signals. Since 1982, in the six months after midterm elections ended, large-cap stocks have risen an average of about 15% on a market-cap-weighted basis and about 16% on an equal-weighted basis; over the following year, both measures gained about 22% cumulatively. Morgan Stanley believes investors generally expected Democrats to sweep the elections and secure a narrow Senate majority. Therefore, given that Democrats also won the Texas gubernatorial election, this outcome may intensify short-term market volatility. However, the bank believes this may also mark the final stage of the rolling market correction discussed since this summer. After the election, renewed escalation of military conflict between the United States and Iran, or further U.S. tariff increases, could also pose short-term risks.
Cross-asset allocation. Based on the midterm election results, Morgan Stanley continues to recommend overweight global equities and underweight core fixed income. So far this year, the bank has held a constructive view on global equities, mainly based on expectations that the AI capital expenditure cycle will continue. Because U.S. technology-related investment may not change much at the aggregate level, Morgan Stanley expects that corporate earnings support across regions, including Europe and emerging markets, will not disappear. The outlook for global fixed income markets is also broadly unchanged. Although sentiment toward AI-related capital expenditure is no longer as optimistic, financing demand for digital infrastructure will still keep corporate credit issuance elevated. Heavy issuance could push credit spreads wider, especially in lower-rated credit segments. Apart from AI factors, oil prices and fiscal risks outside the United States remain important factors affecting equities, yields, and stock-bond correlations, and they deserve attention alongside U.S. political developments. The midterm election results have not materially changed these factors. Until these factors change, Morgan Stanley's asset allocation stance will also remain unchanged: continue overweight equities and underweight core fixed income.
AI market sentiment/capital expenditure. Given that incumbents lost in some key state and local elections, Morgan Stanley believes the impact of this election outcome on AI market sentiment may be the largest, because more durable and broader restrictions may be introduced at the local level. The bank expects the additional adverse effects to be region-specific and not to change the overall narrative of AI capital expenditure development, but they could lead to divergence across U.S. regions: some areas allow new data centers, while other states or municipal jurisdictions do not.
U.S. interest rates. Democratic control of both chambers of Congress means that Republican-led budget reconciliation bills will be unable to advance after the new Congress convenes in January next year, thereby removing the main upward risk to U.S. Treasury financing needs. Pre-election market pricing had already reflected limited investor expectations for additional Treasury supply, because prediction markets assigned only single-digit probability to unified Republican control of Congress, meaning the potential benefit to swap spreads from that outcome may have been relatively limited. The new majority party may seek to delay cuts to SNAP and Medicaid spending at each fiscal policy deadline, which could slightly increase issuance in the 2-year to 7-year sector. Overall, Morgan Stanley believes only modest relative underperformance may appear in the belly of the U.S. Treasury yield curve. If the lame-duck session fails to raise the debt ceiling, the U.S. Treasury will increase coupon auction sizes as planned in February 2027. By then, Democrats may seek to attach their own priority policy demands to the next debt ceiling increase, thereby extending the time needed to resolve the issue. This could cause short-term Treasury bills maturing around the so-called X-date, when the U.S. Treasury is expected to exhaust special financing measures and cash balances, to trade lower and yields to rise, while long positions in the SOFR/federal funds rate basis at the end of the third quarter of 2027 may become increasingly attractive. Regarding AI, related corporate bond issuance has already become a source of supply for long-duration assets, so the market sees a link between data center construction and 10-year and 30-year U.S. Treasuries as well as credit spreads. If state and local restrictions slow construction, smaller AI-related bond issuance plans could reduce the supply of long-duration assets, potentially pushing 10-year and 30-year U.S. Treasury prices higher and yields lower. Morgan Stanley's base case assumes AI-related capital expenditure will remain stable, so it views this as a risk scenario rather than a base forecast. Nevertheless, changes in investors' views on the probability of different outcomes could still provide a path for further declines in U.S. Treasury yields.
U.S. dollar. Morgan Stanley believes the market is pricing in more obstacles to AI-related investment, stronger congressional resistance to another escalation of geopolitical conflict, and rising risks of targeted trade actions. In the short term, Morgan Stanley expects FX trading to align with its defensive market scenario, namely a stronger Japanese yen, Swiss franc, and euro against the U.S. dollar; while the Australian dollar may lag in cross rates because it is more sensitive to AI-related equity market sentiment, especially after Democrats won the Texas gubernatorial election. Morgan Stanley also expects the Canadian dollar to lag relative to low-yield currencies as the market prices in rising risk of higher U.S. tariffs. Combined with potential political and financing headwinds that may limit further escalation of geopolitical conflict, these factors could temporarily put downward pressure on the Norwegian krone/Swedish krona exchange rate.
U.S. economy. Morgan Stanley's overall outlook for resilient economic growth and continued slow disinflation remains intact. Under this scenario, upside risks to economic growth are greater. A possible delay in SNAP and Medicaid cuts could add as much as 0.4 percentage points to personal consumption growth in 2027 and support a faster broadening of consumer spending.
AI-related financing. The focus of AI-related financing may gradually shift from power and data center shell financing to chip financing. When projects reach the chip installation stage, data center construction and energization activities are usually already complete, and these are precisely the links most vulnerable to potential policy headwinds. This shift could drive continued flattening of the credit yield curve.
U.S. healthcare services. A Democratic sweep may be seen by the market as positive for Medicaid-focused managed care companies such as Centene (CNC.US) and Molina Healthcare (MOH.US); while diversified managed care companies such as UnitedHealth (UNH.US) and CVS Health (CVS.US) may see only a relatively modest market reaction. This election result will give Congress greater room to advance Democratic healthcare policy priorities, including restoring enhanced Affordable Care Act (ACA) subsidies or reversing some Republican Medicaid cuts such as work requirements. Although Morgan Stanley still believes major changes in healthcare policy are unlikely before the next presidential election cycle, this election result could change the direction of related policy discussions, especially after several important supporters of Trump's healthcare policy/Make America Healthy Again (MAHA) agenda departed. Shares of Medicare Advantage-focused companies such as Humana (HUM.US) may weaken on the initial market reaction, because Medicare Advantage remains more closely tied to the Republican policy agenda. However, in Morgan Stanley's view, the share price reaction may be significantly more positive for Medicaid-related companies.
Lame-Duck Session: What Happens Next?
Morgan Stanley highlights the following year-end policy catalysts worth watching:
Government funding. The U.S. government has already passed a continuing resolution (CR) that keeps government funding levels at current levels until December 11. At that point, Congress must pass another continuing resolution or pass full-year appropriations bills to avoid another government shutdown. Democratic leadership has signaled a desire to complete consideration of appropriations bills during the lame-duck session. But in Morgan Stanley's view, this election result will determine whether party leaders extend the debate into 2027. Morgan Stanley's previous research noted that government shutdowns have a limited market impact, mainly reflected in delayed economic data releases rather than creating substantial downside economic risk. In its earlier report on Washington policy developments, the bank also mentioned that experts believe the continuing resolution could extend into calendar year 2027 (CY27), and this risk should not be ignored.
Defense. Morgan Stanley's base case is that the fiscal 2027 National Defense Authorization Act (NDAA) will be passed before year-end. Items worth watching in the bill include the possible inclusion of certain export control legislation, such as the MATCH Act, which aims to coordinate export controls among allies, the AI OVERWATCH Act, which would formally codify the Commerce Department's chip export policy into law, the Chip Security Act, which involves chip location verification, and the Remote Access Security Act (RASA). Overall, Morgan Stanley believes the policy direction will be toward further tightening restrictions, and the force driving this trend will increasingly come from Congress, while the U.S. government prioritizes stable relations with China.
Regarding the Department of War's (DoW) base budget and supplemental funding, Morgan Stanley believes the White House's roughly $1.5 trillion budget request is quite aggressive, but in the coming months the bank will watch whether additional funding is approved through the budget reconciliation process. Office of Management and Budget (OMB) Director Russell Vought expressed optimism in early October that Republican lawmakers would push the budget reconciliation bill through the legislative process during the lame-duck session, but the bank still believes related efforts will face considerable resistance.
"Reconciliation 3.0." In addition to supplemental defense funding, the lame-duck session is the last suitable window for Republicans to advance a legislative package on their own. Morgan Stanley believes the legislative calendar is very tight, with multiple priorities still to be handled before year-end. However, according to its interest rate strategists, this would be the main upward risk to U.S. Treasury financing needs. The debt ceiling could also be addressed early through a budget reconciliation package before year-end, but Morgan Stanley believes it is more likely that the debt ceiling issue will become a catalyst in the second half of 2027. Based on projected financing needs, the bank's interest rate strategists estimate that U.S. public debt outstanding will hit the debt ceiling in March 2027, when the debt ceiling begins to become binding. The so-called X-date, when the U.S. Treasury exhausts all special financing measures and cash balances and can no longer meet all debt obligations in full and on time, is expected around the end of the third quarter of 2027.
Leadership elections. Leadership votes will take place shortly after the election, with committee member appointments occurring at the same time. Tonight's election results mean Democrats will gain committee chairmanships, which are typically held by the most senior previous minority members. More broadly, the arrangement of committee members and chairs and the voting results can reflect the possible future direction of overall policy in the relevant areas. For example, healthcare policy may be reflected through arrangements on the Health, Education, Labor and Pensions (HELP) Committee.
Permitting reform. The bipartisan American Affordability and Jobs Act would reform federal environmental review and provide greater certainty for projects that have already received approval. In addition, the bill would require data centers to bear the transmission costs associated with them, effectively turning the Ratepayer Protection Pledge from a voluntary commitment into a federal mandate. Morgan Stanley believes that given major bipartisan policy differences and a limited legislative calendar, whether the bill can pass remains uncertain.
Data Center Restrictions in Focus
Democrat Gina Hinojosa winning the Texas gubernatorial election could increase policy uncertainty and limit future data center supply, thereby raising the relative value and pricing power of existing data center facilities that already have secured power. In August this year, after Texas Governor Greg Abbott ordered a review of all data center projects waiting in the Electric Reliability Council of Texas (ERCOT) interconnection queue, Texas paused some data center interconnection processes. At that time, related interconnection applications had already reached about 474 gigawatts, more than five times ERCOT's historic peak power demand, with data centers accounting for about 90% of new power demand applications. Abbott warned that development on such a large scale could threaten grid reliability and stability, prompting ERCOT to delay the "Batch Zero" transmission planning study for the first projects entering Texas's new large-load interconnection process. Part of the purpose of the review was to distinguish truly credible projects from speculative applications that may overstate Texas's future power demand forecasts.
As for actions the Texas governor can take, these include issuing executive orders to temporarily pause new projects until the state legislature develops clear guidelines. However, if the Republican-led state legislature acts quickly, this pause may last only a few months. Another action is appointing members of power regulators, namely members of the Texas Public Utility Commission (PUCT). Members of the commission serve six-year terms, with the next round of term expirations in 2027. The governor can also provide approval policy guidance to state agencies, for example by halting permits that agencies have not yet issued. Governor-elect Hinojosa has advocated implementing a moratorium before relevant legislation is enacted, applying to permits for new projects rather than projects already under construction.
The following measures would require legislation to implement: promoting more durable policy changes, including tax policy changes such as eliminating sales tax exemptions; granting local governments the power to veto projects, with Governor-elect Hinojosa planning to give local officials the power to negotiate with developers, though this would require changing the law; formally writing ratepayer protections into law; and requiring projects to hire union workers. All of the above measures would require approval from the state legislature.
In Ohio, Democratic candidate Amy Acton was elected governor, also bringing significant delay risk to data center projects in the state. The largest project at risk in Ohio is a 10-gigawatt project involving Nvidia and a major U.S. AI laboratory. Another large project under construction is Amazon's 1.5-gigawatt facility in Fayette County. In May this year, Ohio paused consideration of new data center tax exemption applications while the state legislature studied the growth of the state's data center industry. Tax exemptions are a crucial consideration when data centers choose where to locate projects. Morgan Stanley expects private infrastructure investment platforms (PSPs) with significant Texas exposure may come under pressure. The bank's preliminary judgment is that previously assigned success probabilities for multiple potential data center projects in Texas may need to be lowered, especially those subject to the "Batch process." Morgan Stanley will closely watch statements from Governor-elect Hinojosa, particularly whether she may freeze the final classification of proposed data center projects in the "Batch process." These projects include GLXY's Helios II, CIFR's Colchis campus, and MARA's development projects. Morgan Stanley also wants to learn more about whether projects under construction will be affected, including GLXY's Helios I Phase II and Phase III, HUT's Beacon Point, and multiple CIFR projects. The bank believes these projects are less affected by policy uncertainty.
By sector specifically, Morgan Stanley expects independent power producers (IPPs) as a whole to see a short-term sentiment-driven decline, but before considering the potential upside from data center business, cash flows from existing assets, contracts, and forward price curves will still support valuations. For power equipment and on-site power supply companies, the sector as a whole will likely underperform due to risks that data center industry growth may slow, rather than merely because of Texas market exposure. Utilities with greater Texas exposure are most sensitive to potential downside risks. Potential effects may come from two sources: first, slower data center activity; second, as regulatory commissioners' terms expire, new commissioners may be appointed, with two commissioners' terms expiring in 2027, and new regulatory policies may be more unfavorable to investors.
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