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The US political system is based on the separation of powers between three branches. The President exercises executive power and sets federal policy, whilst Congress – comprising the House of Representatives and the Senate – passes laws and oversees the actions of the executive. The judiciary, with the Supreme Court at its head, interprets laws and ensures they comply with the Constitution. These three branches keep each other in check through a system of checks and balances.
Mid-term elections – the ‘midterms’ – take place every four years, halfway through the presidential term. They do not put the presidency up for election, but do see the renewal of all 435 seats in the House of Representatives, which are held for two years, as well as around a third of the 100 seats in the Senate, whose members serve six-year terms. On the same day, many voters also elect governors, state legislators and various local officials, according to each state’s own electoral calendar.
The stakes therefore go beyond simply renewing Congress. The mid-term elections do not determine who leads the United States, but rather the extent to which the President will be able to govern during the final two years of his term. If his party retains a majority in Congress, he can more easily get his legislation passed and has greater budgetary leeway. Conversely, if the opposition wins one of the two chambers, it can block bills, complicate the passing of the budget and launch a spate of parliamentary inquiries. A hostile majority in the Senate can also slow down or block certain key appointments. The mid-term elections thus represent a decisive moment in the balance of power and are often seen as a referendum on the current presidency.
Analysts are therefore following this election closely, as the composition of Congress directly influences the direction of economic policy. It determines the administration’s ability to change taxation, commit to new spending, reform regulations or support certain strategic sectors. The result may also affect budget negotiations, the risk of a federal government shutdown and appointments to key posts, particularly at the Federal Reserve. The mid-term elections thus provide indications of the future trajectory of deficits, interest rates and growth.
This ‘referendum’ aspect takes on particular significance this year, as a gap is emerging between the economic ambitions set out at the start of the term and the actual trajectory observed. The ‘3-3-3’ economic programme promoted by the President’s team was based on three objectives: to boost growth to 3 per cent, to reduce the federal deficit to 3 per cent of GDP, and to increase US energy production by the equivalent of 3 million barrels of oil per day.
At the halfway point of the term, these commitments stand in stark contrast to the actual trajectory. The federal deficit remains well above the announced target, real interest rates have reached their highest levels in two decades, and questions about the sustainability of US growth are mounting. The energy issue adds to the challenge: whilst tensions in the energy markets are driving up prices, the boom in artificial intelligence and data centres is rapidly increasing demand for electricity. This trend is testing the ability of the US energy supply to keep pace with investment without reigniting price pressures.
This loss of support is reflected in the President’s approval rating, which has fallen to 37 per cent according to the Wall Street Journal. The last President to record such a low rating in the run-up to the mid-term elections was Harry Truman, in 1946. Since 1970, low presidential approval ratings have generally been associated with a significant loss of seats for the ruling party in the House of Representatives. However, this relationship is not foolproof: approval ratings contribute to the outcome, but the economic climate, the electoral map and the specific characteristics of each election can either mitigate or amplify the electoral backlash.
At the end of September, Kalshi participants considered a Democratic victory in both chambers – a ‘Democratic sweep’ – to be the base case scenario, assigning it a probability of around 61 per cent. The scenario of a Democratic House and a Republican Senate – ‘D House and R Senate’ – is priced at nearly 29 per cent, compared with around 1 per cent for a Republican victory in both chambers, or a ‘Republican sweep’. The probability of a Republican setback has increased since early September, with just a few weeks to go before the election. A similar trend had already been observed in March, shortly after tensions in the Middle East began. Kalshi is a regulated US platform on which participants trade contracts linked to the outcome of future events. The prices of these contracts fluctuate in real time in line with opinion polls, political developments and new information: they reflect participants’ expectations, not a definite forecast.
For investors, the key issue is the President’s ability to implement his agenda. Control of Congress determines budgetary and fiscal decisions, regulatory developments, the trajectory of deficits and the volume of US Treasury bond issuance. It can also alter the outlook for sectors particularly exposed to government decisions, notably defence, energy, healthcare and technology. Financial markets may therefore react as the mid-term elections approach, although their performance depends simultaneously on many other factors. The chart below shows the average performance of the S&P 500 over the six months – or 126 trading days – surrounding the mid-term elections. Time 0 corresponds to election day, and the index is set to 100 on that date. The analysis covers the 24 elections held since 1930.
It can be seen that performance tends to be negative in the six months leading up to the election, but that this trend reverses approximately one month (21 days) before the elections. This reversal is explained by the fact that, during this period, uncertainty regarding the outcome diminishes. Over the following six months, the S&P 500 gains 10.7 per cent on average. This return is higher than the index’s average return, which stands at around 6.5 per cent per annum over the long term. This confirms that investors do not favour periods of uncertainty.
Performance also varies depending on the political outcome of the election. The chart below distinguishes between elections in which the president’s party loses at least one of the two chambers – classified as ‘Defeat’ – and other elections, classified as ‘No Defeat’. Historically, episodes of defeat are associated with weaker average performance both before and after the election: in the six months following an election, in the event of a defeat, the average return is 6.6 per cent (10.7 per cent for all elections). This difference is consistent with higher political uncertainty, which dampens risk appetite before the election and limits the subsequent rebound. However, it does not allow us to isolate the specific effect of the election result from that of the economic and financial context. On average, contrary to what had been observed for all elections, no significant trend emerges during the month preceding elections classified as defeats.
The pattern is different in elections without a defeat: after trading sideways for most of the pre-election period, the markets on average record a sharp rebound during the final month before the vote, then continue to rise over the following six months to achieve an average return of 14.3 per cent. The frequency of this phenomenon is also noteworthy: in 70 per cent of elections without a defeat, the post-election return on the S&P 500 exceeds 10.7 per cent – the average performance calculated following all elections. This historical pattern would appear favourable to investors, but current probabilities suggest that such a scenario is unlikely to recur in the upcoming mid-term elections.
The identity of the party suffering the defeat appears to have a limited impact on the markets’ post-election reaction. The chart below shows a similar average performance following the election, regardless of whether the defeat affects the Republicans or the Democrats. The trajectories diverge more significantly in the run-up to the election: Republican defeats are associated with weaker performance in the six months leading up to the election. Given the limited number of observations in each subsample, however, this difference should be interpreted with caution.
Ultimately, the mid-term elections are less a clear signal of market direction than a test of the president’s ability to pursue his agenda. Historical precedents suggest that the lifting of electoral uncertainty is generally favourable for US equities, but that this support tends to be more limited when the ruling party loses control of at least one chamber. Against a backdrop of low presidential approval ratings, persistent economic concerns and the prospect of a Republican setback, investors will therefore need to distinguish between historical patterns and the macroeconomic factors that will continue to drive the markets beyond the election.
