Congressional control's impact on US fiscal policy and markets

US elections can substantially affect financial markets, not just by deciding who holds power but also by shaping expectations for future fiscal policy. A key feature of the US political system is that Congress controls government spending and taxation decisions, meaning election results have the potential to alter the economic landscape.

When a single party holds both chambers of Congress, passing legislation tends to be simpler. In contrast, divided government—where different parties control the presidency, the House and/or the Senate—can lead to political gridlock, making major fiscal changes harder to achieve. These political dynamics matter because fiscal policy influences economic growth, inflation, government borrowing and, ultimately, the outlook for Federal Reserve monetary policy.

How congress controls fiscal policy

The US Congress is central to determining fiscal policy via three primary channels: government spending, taxation and borrowing. It approves federal spending through appropriations legislation, deciding how much money is allocated to areas such as defence, infrastructure, healthcare and social programmes. While the President can propose a budget, Congress ultimately decides which spending legislation to pass.

Congress also sets federal tax policy. Changes to corporate taxes, personal income taxes and other forms of taxation can affect household consumption, business investment and government revenues. Tax legislation must pass both chambers before it reaches the President.

When federal spending exceeds tax revenues, the government runs a budget deficit and must borrow to cover the difference. Congress authorises borrowing and manages the statutory debt ceiling, while the Treasury handles the issuance of government securities. These three channels are closely linked. Higher government spending or lower taxes typically increase the fiscal deficit unless offset by other measures, while spending cuts or tax increases can reduce borrowing needs.

Why divided government can limit fiscal expansion

When the President's party does not control both chambers of Congress, passing major fiscal legislation becomes more challenging. For instance, a Republican President seeking additional tax cuts or higher defence spending may find it difficult to gain approval from a Democratic-controlled Congress. The opposition can block legislation, demand concessions or negotiate changes that lessen the overall fiscal effect.

This can lead to a more restrictive fiscal environment, with fewer opportunities for large spending packages or additional tax cuts. However, divided government does not automatically result in fiscal contraction. Congress can still reach bipartisan agreements, especially on politically important areas such as defence spending, infrastructure and disaster relief. Existing spending programmes also continue unless legislation alters them.

Congressional control does not give Congress complete authority over the President's foreign or trade policy. The President retains significant executive power over tariffs and military operations, though Congress has important constitutional powers over trade regulation, declarations of war and government funding. A divided Congress can constrain domestic fiscal expansion without necessarily blocking the administration from pursuing its broader geopolitical or trade agenda.

How congressional control influences financial markets

The implications for financial markets depend on how traders interpret the resulting fiscal outlook. The same political outcome can affect different asset classes in different ways.

Treasury yields

Government borrowing is one of the most direct channels through which fiscal policy affects bond markets. More fiscal expansion generally means higher government spending, larger deficits and potentially greater Treasury issuance. If markets expect increased borrowing, they may demand higher yields to absorb the additional supply of government debt. Fiscal expansion can also support economic growth and increase inflationary pressures, potentially pushing both real and nominal yields higher.

Conversely, expectations of fiscal restraint can lower projected borrowing requirements and inflationary pressures, creating room for Treasury yields to decline. However, if fiscal restraint is expected to weaken economic growth, markets may increase demand for government bonds, pushing yields lower even without a meaningful reduction in Treasury issuance.

The US dollar

The dollar is influenced by several factors such as economic growth expectations, capital flows and risk sentiment. The most important factor, however, is interest rate expectations.

Fiscal expansion can support the dollar if it strengthens economic growth and pushes Treasury yields higher as Federal Reserve rate hikes become more likely. Fiscal restraint can have the opposite effect. Lower borrowing expectations and reduced inflation pressures may weigh on Treasury yields and interest rate expectations, making the dollar less attractive, particularly at overstretched levels.

Equities

The impact on equities is more nuanced because different sectors respond differently to fiscal policy. Looking at the broader stock market, the main effect is on growth expectations. Fiscal expansion generally supports aggregate demand, benefiting companies through stronger consumption, investment and government contracts. Tax cuts can also boost corporate profitability by reducing the tax burden on businesses.

Conversely, fiscal restraint can weigh on economic growth and corporate earnings, especially in sectors that rely heavily on government spending or domestic demand. However, lower Treasury yields can provide some support to equities by reducing the discount rate applied to future corporate earnings and making bonds relatively less attractive. This means that a politically driven decline in yields can support equity valuations even if the underlying fiscal outlook becomes less favourable.

Why markets react to expectations rather than actual policy changes

One of the most important concepts in trading is that financial markets are forward-looking. Traders do not wait for legislation to be passed before adjusting their positions. They continuously assess the probability of different political outcomes and incorporate those expectations into asset prices.

For example, if markets expect that a divided Congress will prevent additional tax cuts and spending increases, Treasury yields and the dollar may start declining before any fiscal legislation changes.

Positioning also matters. If investors are heavily positioned for a particular political or economic outcome, even a relatively modest change in expectations can trigger significant price movements as those positions get unwound.