A new research report from China Merchants Securities indicates that the U.S. midterm elections are transitioning from the "candidate competition and fundraising" phase into the "campaigning and mobilization" stage. By early September, most state primaries have concluded, shifting the focus to swing states and pivotal races. Meanwhile, ongoing judicial disputes over mail-in voting rules could heighten uncertainty surrounding the voting, vote-counting, and post-election challenges. China Merchants Securities outlines three potential scenarios for the midterm outcomes: a divided Congress with Democrats taking the House and Republicans retaining the Senate, a Republican sweep, or a Democratic sweep.
Current State of the Midterm Races
The election cycle has moved past the primary season, with attention now centered on battleground states and key Senate contests. Legal battles over mail-in voting procedures remain unresolved, which could inject unpredictability into the voting process and any subsequent disputes. The cost of living has become the dominant issue for voters. President Trump's approval ratings on economic matters like inflation and household expenses are notably low, though he fares better on immigration. If the Iran conflict further escalates oil prices and inflation, it could amplify voter dissatisfaction with living costs.
National polls currently favor Democrats, while Trump's personal approval ratings face sustained pressure. However, historical experience over the past decade shows that polling and final results can diverge significantly, making specific districts and the structure of seats up for election equally important. Institutional ratings from the nonpartisan analysis group CPR show Republicans holding a slight edge in non-swing House seats, while Senate control appears highly competitive, hinging on six key battleground seats. Market pricing on the prediction platform Kalshi leans toward Democrats, forecasting roughly 227 House seats and an approximately 85% probability of House control, while the Senate remains a near coin flip. Overall, institutional ratings and market pricing diverge sharply on the House, but the Senate is widely considered a toss-up.
Historical Impact on Congress and Markets
Historical patterns reveal that the president's party typically loses ground in midterms, especially in the House. Since 1946, the president's party has lost seats in the House in 18 of 20 midterm elections, with control of the House and Senate each changing hands seven times. Lower presidential approval ratings generally correspond to larger seat losses for the ruling party, a trend that holds more strongly in the House. The Senate, by contrast, is more heavily influenced by the specific map of seats up for election and battleground states. It's worth noting that a potential escalation in Middle East tensions after this election could disrupt these historical norms.
In terms of market behavior, U.S. equities tend to trade weakly before midterms but often recover afterward. The recovery is more pronounced following a president's first term compared to a second term. The Nasdaq typically shows greater elasticity, with sectors like information technology, consumer discretionary, industrials, and financials performing relatively well in the six months after the election. Treasury yields and the dollar show no consistent midterm pattern, instead responding more to inflation, growth, and monetary policy factors. Gold often posts relatively strong gains following midterms. Overall, congressional control appears to influence the magnitude of asset repricing and sector composition rather than dictating a single market direction.
Potential Dynamics Under Different Congress Scenarios
Intensifying internal divisions within the Democratic Party may hinder its ability to unify. First, a majority of Democrats do not fully align with the party's broader platform. Second, some progressive left-wing members have openly suggested replacing House Democratic Leader Hakeem Jeffries. Third, centrists are also beginning to challenge the party's leadership publicly. This has created a two-way pull within the party: progressives view the leadership as insufficiently aggressive, while centrists in swing districts worry that an overemphasis on national partisan battles could undermine their local electoral interests. This structural friction makes it difficult for Democrats to mount a fully coordinated national campaign, raising doubts about whether they can capture the House or even both chambers as markets increasingly expect.
Should Democrats reclaim the House, renewed investigations and potential impeachment proceedings against Trump are likely. Investigations into Trump and his family appear almost certain, with House Democrats having already prepared plans for broad scrutiny of the former president's administration and family back in March. If investigations yield unfavorable findings, impeachment efforts would likely follow, though the probability of conviction is extremely low. The symbolic and long-term benefits of such moves matter more. Through investigations and impeachment attempts, Democrats could pressure Republican senators and constrain their political influence, while also tying Trump's behavior to the Republican Party to set the stage for the 2028 election.
Scenario Analysis: Possible Midterm Outcomes
In the first scenario, a divided Congress with Democrats controlling the House and Republicans holding the Senate aligns most closely with current market expectations, potentially causing the least disruption. The key impact of a Democratic House on the Trump administration would be fiscal. Since budget reconciliation requires both chambers to approve a budget resolution, Democratic control of the House would block unilateral fiscal legislation unless bipartisan negotiations occur, as seen last year, giving Democrats greater leverage. A deadlocked government would likely prevent major policy shifts, and constrained fiscal space could push Trump to seek more concessions from the Federal Reserve, potentially reigniting questions about central bank independence or creating friction between the Fed and the administration, making the liquidity environment less favorable.
The second scenario, a Republican sweep, would likely surprise markets most. However, as noted, a divided Democratic Party could make this outcome achievable. Fiscal spending could ramp up significantly, and previously stalled deregulation and reindustrialization policies might resurface. Markets could reignite the "MAGA trade," with risk appetite improving substantially, technology stocks gaining fresh momentum, and liquidity conditions potentially improving.
The third scenario, a Democratic sweep, also carries a low probability but warrants consideration. While losing both chambers could limit Trump's legislative agenda, it might paradoxically push him to rely more heavily on executive orders, emergency declarations, and regulatory actions. If bipartisanship fails to achieve a balance, Democrats could pursue investigations and impeachment attempts. Trump's focus might shift from domestic to foreign affairs, raising geopolitical uncertainties and potentially intensifying market concerns over dollar-denominated assets.
Risk Considerations
Key risks include global economic and policy developments exceeding expectations, as well as geopolitical risks rising beyond current projections.