The economics of the US midterms

A personal view from Debapratim De, Deloitte’s Chief Economist in the UK.

The economics of the US midterms

The US midterm elections delivered a staggering loss for president Trump's Republican Party last week.

Midterms are often difficult for the party in the White House but this defeat was unusually broad. The Democrats captured majorities in both chambers of Congress - the Senate and the House of Representatives - and won the House by the largest margin of the national popular vote in 50 years. To add to that, the Democrats made deep inroads into state legislatures in several Republican strongholds, including Texas and Georgia.

On the face of it, Mr Trump's party suffered these losses despite the US's robust economic performance. Momentum remains strong and has picked up recently, with a rapid acceleration in growth in the third quarter. Unemployment also remains low. The IMF expects the US to be the fastest growing G7 economy this year.

But these headline figures conceal two important facets of the US economy that have shaped consumer sentiment and help explain the Republicans' electoral outcomes.

First, US activity is increasingly driven by the boom in AI investment. Dutch bank ING estimates it to have accounted for almost a third of growth this year. Spending on data centre buildouts, chips and software has supported jobs in construction and other industries across the AI supply chain that manufacture in the US. But a large chunk of the investment is on imported goods and its wider benefits are felt elsewhere. So, the buildout boosts GDP but its impact on the disposable incomes of most US households has been limited so far.

Second, renewed inflation and higher mortgage rates have led to dissatisfaction among voters. Tariffs on imports and the war in Iran have significantly raised price pressures, eroding consumer spending power. US inflation is now running at 3.7%, almost a percentage point above its recent average and has outpaced wage growth in recent months.

Higher borrowing costs have added to this pressure. The average rate on a new 30-year fixed mortgage - the most common US mortgage product - is 7.2%, up from below 6% in February. Mortgage rates are linked to yields on long-dated treasuries, which have risen this year amid expectations of rate hikes by the Fed to counter inflation, a bulging fiscal deficit and growing competition for funding from AI investment.

Exit polls showed that the economy was the biggest issue facing the US electorate, with almost 90% pointing out the cost of living as a crucial or major factor determining their vote. Diesel prices, which hit an all-time high in September, were a key factor shaping outcomes in agricultural states such as Iowa and Kansas, with the latter sending a Democrat to the US Senate for the first time in nearly a century.     

So, what does the outcome mean for the US and global economies?

Markets have had their say. The price of crude oil is down sharply, from $120 a barrel to around £97, as investors revised upwards the chances of a meaningful resolution to the war in Iran. Treasury yields have also declined, pointing to reduced odds of an expansion in the US deficit. And US tech stocks sold off due to concerns over a slowdown in data centre buildout and potentially greater regulation of AI, as a result of the elections.

On the conflict with Iran, the incentives do seem to have shifted towards a quicker resolution. President Trump has acknowledged the impact of the war on the Republicans' electoral performance and recent statements by him suggest an immediate escalation is "unlikely". In fact, with the Trump administration's focus likely shifting towards foreign policy, like that of many other US presidents after midterms, striking a deal with Iran would be high on its list of priorities.

US allies in the Gulf would also prefer a swift end to this conflict while Iran, with record-high inflation of almost 100% and the rial in free fall, seems close to its threshold for tolerating economic pain. Oil futures and options reflect this reduction in escalation risk. But a deal has yet to be struck and further disruption cannot be ruled out. Iran reported attacks on three oil tankers last Thursday demonstrating that shipping through the Strait of Hormuz remains under threat.

On the deficit, the Democrats’ capture of the Senate and the House points towards legislative gridlock when the new Congress takes office in January. Major changes to tax and spending will be harder to enact, reducing the prospect of further deficit-expanding stimulus.

The election outcomes also suggest a potential shift in policymaking towards the centre, which typically points to greater fiscal responsibility. The swing towards Democrats endorsed by left-wing presidential hopeful Bernie Sanders was much smaller in the Senate elections than that for those without his endorsement. Among the Republicans too, the odds of candidates to the relative left of Mr Trump, such as Ron DeSantis, securing the nomination for presidential elections in 2028 have risen since the midterms.

On AI, the elections do point to growing public aversion to data centres. Voters approved 39 of the 45 proposed moratoria on data centre development that were on the ballot. The incoming Democratic governors in Texas, Georgia and Ohio have also pledged moratoria on new data-centre construction, raising the risk of delays to AI infrastructure investment. According to market intelligence firm Cleanview, 41% of America’s planned data centre capacity is located in states where new governors favour a pause.

While the buildout seems likely to eventually shift to more permissive states, provided demand remains robust, this geographical and regulatory realignment will delay development in the short term and raise investment costs. This could prove advantageous to cloud-based service providers that have already operational data centres serving short-term needs but disadvantageous for chip manufacturers and other suppliers exposed to significant delays in demand. This will also temporarily ease the pressure on hyperscalers to raise large amounts of capital to fund these buildouts.

Aside from these immediate implications, the midterms point towards greater use of executive power by the Trump administration over the coming years and a focus on foreign policy similar to former presidents. Alongside the focus on Iran, this could also imply moves towards resolving the war in Ukraine, greater engagement with China and on a potential expansion of the Abraham Accords. But the scope of engagement on these issues and outcomes remain subject to significant uncertainty.   

Overall, the midterms highlight the disconnect between good headline US growth and public perceptions about their own prospects. Voters have delivered a clear political verdict, but the economic impact is likely more nuanced than a quick reading of markets would suggest.