How a Divided Congress Affects the Stock Market and Bond Yields

The Dow Jones gained around 3% after the U.S. midterm elections, as Democratic gains secured control of Congress and set up a tougher political environment for President Trump. A divided Congress affects the stock market and bond yields by making sweeping legislative change harder to pass, which leaves investors pricing in fewer disruptive policy surprises. Treasury yields and global bond yields moved lower alongside the equity rally as investors reassessed the outlook for fiscal policy and government borrowing. For markets, the trade-off sits between policy stability and the problems that gridlock brings with it.

Fiona Cincotta, StoneX Senior Market Analyst, covers macroeconomics across forex, equities, commodities and crypto assets, with a focus on U.K., European and U.S. market themes. That coverage gives insight into how U.S. politics, oil prices and Treasury yields are feeding into equity markets after the midterm elections.

Key Themes

• The Dow Jones gained around 3% after the U.S. midterm elections as a major source of uncertainty cleared.
• A divided Congress makes sweeping legislative change harder, so markets are pricing in fewer disruptive policy surprises.
• Treasury and global bond yields are lower as investors reassess fiscal policy and government borrowing.

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Divided Congress Lowers Policy Risk for the Stock Market

Cincotta points to "a divided Congress that actually makes it much harder for the Trump administration to push through sweeping legislative changes", and the U.S. stock market is treating that limit on Washington as a positive. Investors who had been concerned about unpredictable policy decisions on trade and government spending are reassessing the risk of sudden policy shifts. Gridlock is not free of cost, and Cincotta sets out the balance by noting that while "political gridlock does actually have its own problems, Wall Street can often prefer policy stability over uncertainty". Equity markets are pricing in fewer disruptive policy surprises, which helped lift the Dow Jones after the midterm elections.

Treasury Yields Fall and Lift Demand for Riskier Assets

Treasury yields and global bond yields moved lower after the U.S. midterm elections as investors reassessed the outlook for fiscal policy and government borrowing. According to Cincotta, "falling Treasury yields helped spark risk sentiment and demand for riskier assets such as equities". Oil prices fell 8% on a possible de-escalation of the Iran conflict, reducing inflation expectations along with energy costs for businesses and households. As a result, the Federal Reserve can have greater flexibility on the path for interest rates, tying bond markets directly to equity sentiment.

Stock Market Response to Gridlock Shows Up in Payrolls and Yields

The stock market's response to a divided Congress shows up in inflation expectations, interest rate expectations, corporate earnings and the U.S. nonfarm payrolls report. The nonfarm payrolls report measures the pace of U.S. job creation, which feeds into expectations for Federal Reserve policy. Treasury yields show how investors are weighing fiscal policy and government borrowing. Oil prices carry the geopolitical risk premium that shapes inflation expectations for businesses and households.

--- Written by Frédéric Guétin, StoneX Media Producer

--- Expert: Fiona Cincotta, StoneX Senior Market Analyst