Markets weigh a divided Congress

Donald Trump and his Republican party lost control of both the House of Representatives and the Senate in the midterm elections, and analysts said the arrival of an erratic lame-duck president would carry significant implications for financial markets, growth, inflation, government borrowing costs and living standards.

The immediate reaction in stock markets was volatile, and the outcome was only partly read as negative:

• •Markets initially dropped in early trading in Asia overnight, but rallied as investors digested the result.
• •Investors took it positively that the president conceded the result and acknowledged the impact of the Iran war.
• •Trump's warning that he will become "Mr Veto" raises the prospect of a turbulent finale to his term.
• •Traders expect the Democrats to take a tougher line on AI regulation and the datacentre rollout, questioning a driver of recent stock market growth.

Inflation and the Iran war hang over the result

The economic backdrop was central to the vote. Surging inflation, driven by the deeply unpopular war and a chaotic tariff policy that devastated small businesses, was key to the midterm result.

The numbers behind the discontent are stark:

• •US diesel prices surged to a record high in August, while headline inflation has risen to 3.7%.
• •The US-Israeli invasion of Iran closed the Strait of Hormuz, reigniting global inflationary pressures in the biggest energy price shock of the modern age.
• •Oil has fallen back on hopes of a diplomatic breakthrough, but Brent crude, the international benchmark, remains above $100 a barrel against a prewar level of about $70.
• •The International Monetary Fund expects global headline inflation to rise to 4.7% this year, with energy-importing countries hit hardest.

Central banks keep raising rates

Higher inflation has already forced central banks to act. The US Federal Reserve defied pressure from Trump, increasing the cost of borrowing for the first time since 2023, and investors anticipate at least one more increase.

Further moves are expected elsewhere. The Bank of England is expected on Thursday to raise rates, while the European Central Bank is also expected to push up borrowing costs.

With Republicans out of Congress, Trump lacks the votes to confirm new appointments to critical public bodies, including new Fed governors, adding to the pressure on monetary policy.

Holger Schmieding, chief economist at Berenberg, said voters had "rejected Trump and his somewhat authoritarian penchant for crony capitalism. [That] shows that US institutions and its checks and balances work".

What a lame duck president can still do

A weakened president retains sharp tools. Trump could still use his veto powers, which can be overturned only if two-thirds of both chambers agree. But gridlock cuts both ways: it could block new Trump tax and spending measures, restricting fiscal stimulus to boost the economy while also limiting a further rise in borrowing and debt.

Key dates and risks now in play:

• •Politicians must agree government spending authorisation by 11 December to avoid a shutdown - the logjamed system's first major test.
• •There are concerns Trump could take a more aggressive approach to foreign policy, with potential to intensify the war in Iran, now that his domestic control is weakened.
• •Analysts say crushing defeats for Maga candidates will hurt the president's authority and could pave the way for more cooperation between Republicans and Democrats in Congress.
• •Political turbulence and presidential actions on trade and immigration could put US growth at risk.

Investors are also watching AI, whose investment spillovers have been felt globally, including bolstering the UK economy. Tech industry leaders were already cooling on the rollout of AI amid concerns over cyber risks, and many investors feared a bubble in the US stock market; a Democratic clampdown could hit US investment and growth. Allianz analysts say the scale of AI investment and its growth potential could mean the left-right political playbook is less predictable than in the past.

Analysts say inflation and, most importantly, the prospects for de-escalation in the Middle East are the main factors to watch, with the 11 December spending deadline the logjamed system's first major test.