US midterms: Fiscal, market and geopolitical implications of the "blue wave"

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Kathleen Mellody: Welcome to J.P. Morgan's Making Sense. My name is Kathleen Mellody and I'm the head of federal government relations here at J.P. Morgan. Today we'll be looking at what the latest election outcomes could mean for policy, markets, and geopolitics, from the US midterm elections to the Israel and Brazil presidential elections. First, I'll be joined by Bruce Kasman, our chief global economist, and we'll discuss how the US election result could shape US fiscal policy and federal borrowing and what transmission channels to watch globally, especially rates and effects. Then Derek Chollet, head of the J.P. Morgan Chase Center for Geopolitics, will join to take a broader view -- what these results may mean for the policy agenda going forward for US-China relations and implications for the Middle East and Latin America. So, with that, let's get started. Bruce, thank you so much for joining us.

Bruce Kasman: Thanks, Kathleen, for having me.

Kathleen Mellody: So let's start with the US midterm elections. Now that Democrats control Congress and Republicans still hold the White House, what are the main moving parts for US fiscal policy next year? How do you see this affecting the budget deficit and could it change anything on tariffs?

Bruce Kasman: Well, I think there are basically two moving parts here in a world in which you have a Congress and Democratic hands and a White House and Republican hands. One is there are significant cutbacks in spending on social benefits, particularly healthcare, that are built into the budget for next year. And we think there's a pretty good chance that with the Democrats and Congress having leverage, particularly as we have to vote for a budget and a debt ceiling next year, a debt ceiling extension, that what will happen here is that those cutbacks will get rolled back. That already has been in our forecast and was something we expected even if the Democrats had only taken the house. So from our macroeconomic point of view, that's already built in the cake. I think that's probably the biggest issue is we're not going to get the full cutbacks. That will have an impact on the budget deficit. And then I think the other question here is whether anything happens on tariffs in a world in which there is investigations that are ongoing and there is, I think, an appetite in Congress for trying to roll them back. I think that's a tension which we're not at this point feeling very confident on how it's going to play out. Our baseline view though is that actually tariff rates do go up somewhat next year.

Kathleen Mellody: Thanks, Bruce. That's really helpful. Has the midterm result changed your growth or GDP forecast or does it mostly reinforce your current baseline and does it shift the risks around that outlook?

Bruce Kasman: So on the issue of how does the forecast change, I'd emphasize that we had already built in a shift in fiscal policy that's aligned with the Democrats having taken at least one body of Congress. And also we have been building in oil prices falling as geopolitical conflict starts to wind down next year. I would say the most important thing in that context is these things reinforce what's already in our baseline. It takes out some of the risk of oil staying more elevated. It takes out some of the risks of US fiscal policy tightening. I think where we open up some risk that we haven't talked about in our forecast here is the opportunity that fiscal policy actually shifts somewhat more aggressively towards easing. And that has both the impact on possibly adding a little bit to growth, but perhaps also in that context starting to push pressure on the budget deficit, which I think can translate into somewhat higher interest rates in 2027. So these are more in the direction of biases on the risk side than anything that is having an impact on our baseline forecast, which I'd emphasize again, pretty much the election outcome is reinforcing the kinds of shifts both geopolitically and in the US fiscal scene that we had been anticipating already.

Kathleen Mellody: Thanks for that, Bruce. How are the US election results reverberating across the global economy? Do you see the bigger impact coming through foreign policy and oil prices or what about the implications for tech spending?

Bruce Kasman: Well, I think they are transmitting, but it's going to be more about what impact this has on foreign policy. And there, of course, the president still has quite a bit of discretion. We're more focused on what signal that he takes from the election and how, if at all that changes things. The biggest moving piece so far has been the oil price move, which if it was validated with some kind of deescalation of tensions in the Middle East does have, I think, an important role to play in the macro outlook. It is again something that is built into our forecast. We have been assuming oil prices make a significant step down in the first half of next year. I think what the election does is on the margin at least, it reinforces the idea that that's the direction we're going in. There's obviously another story here around tech stocks and tech spending more generally around possible more restrictive policies that come at the state and local level and possibly at the federal level. We tend to downplay that as a more meaningful impact on what happens to the tech spending cycle. There, we think it's far more important what's going on with Fed policy, what's going on with access to credit, and more generally whether or not businesses are going to be as confident and comfortable spending as they certainly seem to be suggesting in their plans for 2027.

Kathleen Mellody: Really helpful. One of the storylines we've seen emerge from the Democrats sweeping victories is concern that it might herald a slowdown in the AI boom. Does your team share those concerns with regards to growth?

Bruce Kasman: Well, I would say that this is a election result which will reinforce the continuing pressure we're starting to see build towards limitations on data center build out. And that I think reinforces a case that there will be some slowing in tech spending in 2027. Again, that is built into our forecast and we're not feeling what's happened in this election is going to change that course. I think the questions here that matter most is whether or not that's going to have a more meaningful effect on earnings expectations, constraints in the sector, and put more downward pressure on asset prices and possibly have some impact on credit access. Those are probably the biggest risks is that that shift politically in terms of the concerns that get raised on that create more financial market stress. And if that were the case, that could feed back into the macro outlook. And that is something we definitely are flagging as a concern here as we think about the 2027 outlook.

Kathleen Mellody: Bruce, what's your takeaway on how this midterm result affects the Fed? Does it change how much pressure the administration can put on the Fed and what does a Democratic-led Senate mean for Fed personnel and confirmations?

Bruce Kasman: Well, I think the first thing I would say when we consider the implications of the Fed from this election is we had already been emphasizing in our thinking that the Fed is not, I think, significantly influenced by the pressures that the administration has been putting on it. I do think this has some impact on personnel at the Fed, and it's clear now that the approval process of any Fed official has to go through a Democratic-led Senate. I think that does matter in two ways. One is that the pressure that the administration has been putting on Lisa Cook and to some degree Chair Powell to leave in order to get the opportunity to put more friendly members onto the board, that probably will be to some degree moderated. There's just not much bang for your buck if you can't get the people you want in. I think on the other side, there is more opportunity for members who were potentially interested in leaving but were hesitant because of the risk of who might replace them. Now that risk goes down with the Democrats now being in the position of having to confirm any nominations. So Chair Powell, whose term is up in early 28, might leave early. I think there's some risk that one or two other members of the committee could leave early. We find ourselves with more Fed turnover next year than we had anticipated.

Kathleen Mellody: All right, Bruce, one final question for you. Brazil recently held its presidential elections as well. With Brazil being Latin America's largest economy, how might the election results reshape trade and financial conditions in the region?

Bruce Kasman: Yeah, the Brazilian election was clearly a surprise and Lula being in power in some sense should be viewed as the continuity of policy being the key thing here. I think from our point of view, the key issue is the budget has been stretched. There's a very substantial need for fiscal consolidation. It's not at all clear how well the new Lula administration is going to move in that direction, and we've been adjusting our forecast in the context where markets have been questioning it and have pushed the currency down. We've taken out some easing we had in our forecast for the Central Bank over the next year. I think as you look at the broader implications of this election, I think regional relations are important, particularly the notion that if Bolsonaro had won, there would be a reshaping of Brazil relations with Argentina. There'd be pressure to reshape the Mercasor agreement with possible implications in terms of how US and regional trade played out. These are things which had been starting to be considered and now are in some ways thrown back. And I think on a regional basis, the real issue is to what degree does this reverberate as we start to look towards Argentine elections in 2027?

Kathleen Mellody: Bruce, that's a really helpful walkthrough of the immediate market and economic implications, especially around fiscal pressures, borrowing, and the ways these outcomes could flow through rates, FX, and regional financial conditions. Thanks so much for taking the time to share your thoughts. Now I want to widen the lens and bring in Derek Chollet. Thank you so much for joining us, Derek.

Derek Chollet: Great to be with you. Thanks for having me.

Kathleen Mellody: Derek, you've called the US midterms the defining domestic fulcrum of 2026. Building on what you've just heard and as the desk settles from the US midterm elections, what policy areas are you watching most closely and what could this mean for the broader geopolitical backdrop?

Derek Chollet: Well, sure. And yeah, of course the magnitude of the midterm election really cannot be overstated. I mean, what was a blue wave, everyone is now calling a blue tsunami, and I think the direction of travel was fairly well agreed upon. In other words, there was an expectation that Democrats would win the House and possibly win the Senate, probably win the Senate. But I think the magnitude, the degree of shift we saw, not just having a majority, but a decisive majority in both the House and the Senate was something that very few, if anyone, was really predicting. So we're still sorting through what this will all mean, but geopolitically, on the one hand, it will have significant impact. On the other hand, it won't change much because of course, the President of the United States has a lot of latitude on foreign policy. And as we have seen historically, presidents in the last two years of their second terms tend to pivot to foreign policy. We saw it with Ronald Reagan, we saw it with Bill Clinton, we saw it with George Bush 43, we saw it with Barack Obama, and I do expect we will see it with the Trump administration just because typically presidents in the last two years of their second term, they're dealing with an opposition in Congress. They don't have much chance getting a domestic agenda through and they have more leeway in foreign policy. So I continue to expect to see a very active president on foreign policy, but Congress can, of course, throw sand in the gears. They can try to set an agenda or shape the agenda by proposing legislation and hearings. And I do expect to see some early moves in January when the new Democratic Congress comes into power that will have geopolitical implications, for example, on trade. I do think early on there will be legislation that will be proposed and probably passed certainly with democratic support, but also probably with some Republican support to curb, if not eliminate some of the tariffs that have been imposed against countries like Canada. I also think obviously we will see a major discussion about the Iran war depending on where that conflict is in a couple months. But one of the resounding messages coming out of the midterm was the Iran war is not popular among Democrats nor Republicans. So I do expect we'll see some action on that as well. So look, I think we'll be sifting through what this all means and the implications I know for 2028 later, but I think safe to say we're going to be in a very different policy environment in a couple months than we have been for the last two years.

Kathleen Mellody: For sure. Thank you. And what do you think the new Democratic majority means for US-China relations? Will the coming months likely be marked by stability or renewed volatility?

Derek Chollet: Well, I think at a diplomatic level, I expect for the next couple months we'll seek continued stability. The US and China right now are in the middle of a truce in terms of the trade war that the back and forth we saw a year ago. President Trump will be seeing President Xi twice more this year, both in China when he'll be going to China for the APEX Summit, as well as hosting the President Xi and other world leaders at the G20 Summit in December. So those leader meetings are important because they do provide some kind of ballast in the relationship because both sides have an incentive to keep things kind of calm to let those leader meetings take place. Obviously, it's also an opportunity for two governments to try to iron out differences, but the underlying structure of the relationship and the strategic competition of the relationship is not changed at all. I do expect a Democratic Congress, and this may seem counterintuitive to some, is going to come in probably a little more hawkish on China than the administration has been thus far, and probably with some Republican support. I think what we have seen in the last few years is the strategic consensus in the United States really shift pretty firmly in a hawkish stance towards China and concerns about China's growing economic, political, and military power and its efforts to try to neutralize US advantages in the Indo-Pacific. In that way, the president has been a bit of an outlier in terms of his approach to China, certainly since Liberation Day. And so I do expect to see the debate more accurately reflect, I think, where the balance of views are right now, which is a more hawkish perspective on China.

Kathleen Mellody: Great, thank you. And if we look ahead further, how might the midterm results with such a strong Democratic showing influence the 28 presidential and Senate primaries?

Derek Chollet: Sure. Well, and I think this is the area where the most unexpected piece of Tuesday night is something we're still sorting through because the fact that Democrats were able to carry states that for many years, in some cases, many decades, had never been Republican, a state like Kansas that had not voted for a Democratic senator since the 1930s, a state like Texas that had not voted for a Democratic Senator since 1988, the fact that those flipped and they flipped decisively, not in narrow victories, but in decisive, in one case, double-digit victory in Texas, it opens up the political map in 2028. And so Democrats who in previous presidential elections weren't really spending much time or energy thinking about how to win a state like Texas are now going to be spending time and energy thinking about how to win a state like Texas. And so that opens up a lot of optionality in the presidential race. It will also change the kinds of candidates that are considering running because you have to think, I think what we've seen in the last few years is a discussion in the Democratic Party between the center and the left, and I certainly think that that discussion will continue, but you're looking for perhaps a different kind of candidate that could compete in a place like Texas just as much as deep blue democratic states and the electoral map that we've kind of become accustomed to over the last several cycles of the blue wall in the upper Midwest, there's more diversity of victory, more diversification routes. So that I think will change fundamentally the discussion about what's coming next. And I do expect actually a more centrist discussion in some ways in Washington because most of the Democrats coming in, newly elected Democrats, are folks who flipped seats in red districts. And so therefore they are representing constituents who many of them voted for the Republicans in the last election or many, many previous elections. And so in order for them to be successful, they have to be able to represent those people in addition to the diehard Democrats. So I think that's kind of healthy for our system in a moment where we've been so polarized in a sense that there's very few politicians who seem to have to worry about both sides of the aisle now where there's actually a lot of Democrats coming in who do have to worry about both sides of the aisle. And I think that will change the debate, the policy debate here in Washington a bit.

Kathleen Mellody: I completely agree, and I think on both sides of the aisle, right?

Derek Chollet: Yes.

Kathleen Mellody: Derek, another area that I think has gotten some attention in Washington is the Ukraine war. Do you think that the midterm results have implications for that war going forward?

Derek Chollet: I do in the sense of the US approach to the war. I think it's important to note that there's been consistent bipartisan support for helping Ukraine going back from the very beginning of the war, so for the past four years, and also bipartisan consistent skepticism of Russia and its motives and its trustworthiness. And now you will have solid majorities, Democrats plus many Republicans in Congress that will be looking for ways to provide support for Ukraine and also raise the costs and the pressure on Russia. Prior to the election, a few weeks earlier before the election, the Congress voted in overwhelming bipartisan fashion for a sanctions bill called the Lindsey Graham Act in honor of the late South Carolina Senator Lindsey Graham to give the president greater authority to raise the economic pressure on Russia. So far, that authority has not been used, so I do expect that if in January the new Congress comes in and we're still in the same place, that there'll be legislative action to try to compel the president to use that authority that Congress has given it to raise sanctions, increase sanctions on Russia. And similarly, in terms of the Ukraine support, Congress backed with bipartisan support for many years, significant US support to Ukraine. US kind of got out of the business of supporting Ukraine directly a couple years ago, so I do expect some legislative activity to, again, try to force the administration's hand when it comes to support for Ukraine. Now, the president has the veto power. It's very hard to overcome vetoes because it's a pretty high bar in terms of votes, two-thirds of the House and the Senate. But Ukraine is one of those issues where I could see perhaps cobbling together enough votes to overcome a presidential veto. So we'll see, and this will obviously be unfolding against a backdrop of an administration that is driving very hard towards some sort of deal on Ukraine. There's going to be a meeting in Abu Dhabi soon bringing together the Ukrainians and the Russians. I think the administration, we've seen a lot of diplomatic activity in the last few weeks. So we'll see a kind of renewal of US support for Ukraine, or at least an attempt to renew that support, but alongside what I think is going to be an only intensifying round of diplomacy led by the administration on Ukraine.

Kathleen Mellody: Yeah. So turning to Israel then, this election has been billed as one of the most consequential in the country's history. Are you surprised by the result and how might this change Israel's place in the world?

Derek Chollet: Well, and obviously this has been a month of elections between Brazil, Israel, the United States, and by the way, next year will be a year of elections with elections, particularly in Europe and France and Poland and Italy. I think the Israeli election was surprising on the one hand, not surprising on the other. It was not surprising in the sense of all the polls suggested it was going to be a pretty close election. I think the Prime Minister Netanyahu's coalition, although it lost many seats, it did a little better than people were expecting. One of the surprises is the strength of the Arab parties in Israel. I think a lot of people don't realize or have forgotten that there are Israeli Arabs and there are political parties that represent them, and the Israeli Arab parties did better in this election than they ever have before in any Israeli election since 1948. And so that was a bit of a surprise. And Israel, of course, it's a different system than the United States. It's a coalition government and there are many parties in Israel, and so we are now in the middle of a process that it's going to take weeks, perhaps it's even months for the Israeli political system to come together to forge a coalition to lead. And there are many different permutations of what that coalition might look like, but I expect the next few weeks to be defined by very intense jockeying and horse trading on what might the next Israeli government look like? Could there possibly be a unity government that might still involve Prime Minister Netanyahu? I think one of the broader points I'd make is that we have seen that what the Israeli election and what's been happening in Israel has played an outsized role in the US debate in the sense of there's a lot of discussion here in the US about the impact of the Iran war on the election and the role of money in politics and all of that, and it's kind of intertwined with the election in Israel. And my sense too is that the Israelis also understand that their next government will have an impact on the broader US-Israel relationship here as the debate has been shifting here in the United States on both sides of the aisle, not just among Democrats, but also among Republicans. And as Republicans are sifting through the lessons of Tuesday night and what it means for their future, there are some, including the vice president this week, who's laying out questions about maybe the future of the US-Israel relationship and the implications it will mean moving forward.

Kathleen Mellody: Great. And you really touched on this, but let me just ask it directly. How might the results of the US and Israel elections affect the ongoing conflict in the Middle East? Has the escalation risk increased or decreased?

Derek Chollet: Well, to be blunt, we don't know. I mean, before the election, when I was being asked about the possibility of a significant US military escalation sometime in mid-November, there's a lot of press stories about the possibility of a US military strike on Iran after the midterms. I was saying then, and I believe even more so today, that the lesson of the midterms very well could be we need to find a deal or find a way to pivot out of Iran, that the war was not popular before the midterms. It has not gotten any more popular since the midterms. That said, the US is in a bit of a dilemma here in the sense of the war is not over, it is unresolved. Iran can still threaten the strait. We still see energy prices elevated. And so I think the administration will be grasping for some kind of solution here. Unfortunately, I don't see the Iranians particularly motivated right now to give the US that solution, to give some sort of victory in a way to the United States. So I do think that this is something that while it could recede into the background a bit, in some ways as it has for the last couple of weeks and the military campaign is dialed back or it's a little less intense, we're probably in for a future where this situation will not be resolved and we will see spikes of military back and forth really for the better part of the next two years, I'm afraid.

Kathleen Mellody: Thank you, Derek. Last question for you. Looking at Latin America, how might the Brazil election result buck the region shift to the right, and what are the implications for the rest of the world?

Derek Chollet: Well, the Brazil election was a bit of a surprise for many. I think in the first round of the election in early October, the opposition candidate Bolsonaro, Favio Bolsonaro, was in the lead pretty comfortably by two or three points. And so the expectation was the sitting president, Lula, was going to lose, and he won by a couple points. And so that was a surprise. Now we've seen, is your question noted, a trend in the region towards more right-wing candidates. I don't know that Brazil necessarily represents a reverse trend, but it certainly is booking against what we've seen happen in other countries like Columbia or Chile or some Central American countries in the last year or two. So look, but Brazil, it's South America's largest economy. It's a significant trading partner of the United States. It's no secret to anyone that the president of Brazil, Lula, who just got reelected and President Trump don't always get along. And so there's been some pretty rough back and forth between the two sides on trade. So I think we have to expect that that kind of turbulence will probably remain now that you've got a reelected president in Brazil who feels a little emboldened given that he just was reelected and a president here in the United States that's looking towards the end of his time in office and probably looking to do also big things out there in the world to cement his legacy. And so I think that will have big implications, certainly in the region, but also globally.

Kathleen Mellody: Great. That's so helpful, Derek. We're really thrilled to have you here joining us today, and your insights are just incredible. So thank you very much.

Derek Chollet: Thanks for having me

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