In addition, stocks tend to rally under a divided government. This is because prevailing fiscal policies will likely remain in place as any new measures tabled by one party will be blocked by the other, thereby creating more stability and certainty for investors. “The markets like gridlock,” said Salopek. 

At the industry level, a Democrat–Republican split spells good news for certain sectors, including utilities and energy. “A divided government is a positive outcome for continued outperformance and leadership in the energy sector. Energy companies could continue to thrive when the government puts restrictions on supply, without the headline risk that the government might try to levy a tax,” said Dubravko Lakos-Bujas, Chief Equity Macro Strategist and Head of LATAM Equity Research at J.P. Morgan. “And while aerospace and defense historically benefits from a Republican-controlled government, I would argue that the industry will do well in a gridlocked scenario, given the current geopolitical backdrop.” 

The outlook for Treasury markets

Unlike with equities, a divided government will have limited bearing on Treasury markets. “There is little we can expect on the legislative and fiscal front, so that won’t have an impact on the issuance profile for the U.S. Treasury for 2023—a year in which we see the budget deficit widening and the issuance need increasing, but largely being funded via Treasury bills,” said Jay Barry, Co-Head of U.S. Rates Strategy at J.P. Morgan.

Of course, a divided government could well lead to a debt ceiling standoff. The Treasury is projected to reach its authorized $31.4 billion borrowing limit in early 2023 and Republicans will likely oppose further increases in a bid to cut spending on Democrat-backed initiatives such as Medicare. However, a combination of “extraordinary measures” (temporary accounting maneuvers that allow the government to continue standard operations for a limited period) and cash on hand will likely give the Treasury borrowing capacity well into next year. “The debt ceiling debate probably won’t begin until the first or second quarter of 2023, so at this point, it’s hard to expect it to mean anything for the Treasury markets,” noted Barry. 

The outlook for credit markets

In the same vein, a divided government will not have a significant impact on credit markets. “The reaction function in liquid credit index products is rather benign, and I don’t think the midterm results will materially change anything. We’re still focused on the Fed’s terminal rate and how quickly we get there,” said Stephen Dulake, Global Head of Credit, Securitized Products and Public Finance Research at J.P. Morgan. “The real question is the strength of the recent rally in developed credit markets—to what extent has it been something of a drawdown on 2023 performance?” 

The macroeconomic picture

Overall, a divided government will result in legislative gridlock, limiting the rollout of new taxation or spending initiatives. “We can expect no major legislation over the next two years. It’s safe to say that we won’t see fiscal expansion with a Republican House. The question is, can the House force some fiscal contraction by creating problems through government funding or the debt ceiling?” said Michael Feroli, U.S. Economist at J.P. Morgan. “But until we run into a funding or a debt ceiling issue, we don’t think there are many implications for the macro outlook.”

However, a divided government will likely turn its attention to other economic and political issues. “You’ll see more bipartisan support to take a tougher stance of China—policies that will increase competitiveness and safeguard the supply chain,” said Joyce Chang, Chair of Global Research at J.P. Morgan. “There will be more scrutiny of the Infrastructure Investment and Jobs Act and the Inflation Reduction Act, and there are also bound to be questions on whether free trade could return to the agenda.” 

What do voters want?

Overall, the state of the markets is a key consideration among the American public. The economy remains the top issue for voters, data from Pew Research Center shows, and 70% of U.S. consumers say they are very or somewhat concerned about how the stock market is doing. 

The soaring cost of living is another major topic. Some 95% of American consumers state they are very or somewhat concerned about the price of food and consumer goods, 93% say the same about the price of gasoline and energy and 87% about the cost of housing.

Clearly, Congress has numerous issues to grapple with, from the economy and markets to food, health care and housing. And every move it makes will be closely watched by voters as well as investors, who will be keen to discover where opportunities lie.