Blue
“I try to live in black and white, but I’m so blue,” sang Billie Eilish. The California-born pop star was, no doubt, foreshadowing the midterm election outcome that flipped control of the House and Senate, ending two years of Republican control of Congress. Democrats even won Senate contests in eight states that President Trump won in 2024, including Georgia, Iowa, Kansas, Michigan, North Carolina, Ohio, South Carolina, and Texas.
To observers familiar with political history, this outcome was not a surprise (though the extent of the landslide, especially in state elections, may have been). There has long been a strong inverse relationship between presidential approval ratings and congressional seat losses; presidential approval ratings below 40% are associated with wave elections, while ratings above 50% generally reduce the risk of significant losses. According to Ballotpedia’s 30-day polling average, President Trump’s approval rating was 38% before the midterms, signaling that a strong Democratic performance was probable.
As recently as January 2025, however, Trump’s approval rating was 54%, meaning that the president has experienced marked deterioration over the previous 22 months. For many Americans, and as Vice President JD Vance put it, “the reason we [Republicans] lost [the midterms] is the [Iran] war. The president himself said so last night.” Exit polls, meanwhile, suggested that voters’ unhappiness with corruption, inflation, and gas prices was among the biggest factors behind Republicans’ poor performance.
Since 1857, the federal government has experienced 47 periods of unified government, whereby one party controlled the White House, Senate, and House. Twenty-four of those periods were Republican-controlled and 23 were Democratic-controlled. Unified government is also often short-lived. For instance, in 11 of the most recent unified governments, the president’s party lost at least one chamber in eight midterm elections and lost both chambers in five midterms (Figure 1).
House losses are especially common following periods of a unified government. For example, in 2010 under President Obama, Democrats lost 63 House seats and control flipped to Republicans, marking the largest House reversal of the past six midterms. In 2022, Democrats lost nine House seats under President Biden. And last week, Republicans lost 41 seats in the House.
In the aftermath of what some commentators are calling the “blue tsunami,” several developments are likely. First, divided government often produces legislative gridlock. Second, congressional oversight of the executive branch increases, as the opposing party conducts investigations, holds hearings, and otherwise scrutinizes executive branch actions more closely. Third, presidents adjust their governing strategy.
For instance, after Democrats lost control of Congress in the 1946 midterms, President Truman increasingly blamed the Republican majority for blocking his legislative agenda; Truman also made the Republican-controlled “do-nothing Congress” a central target of his successful 1948 reelection campaign. In 1994, President Clinton attempted to triangulate issues by adopting portions of GOP proposals while maintaining core Democratic priorities. In 2006, President Bush relied increasingly on executive authority and administrative actions to pursue his agenda. As for Trump, after the midterms last week he told CBS News that he is “[looking] forward to working with you [Democrats] for the good of our country.” In the same interview, he added: “I think they’re gonna want to work with me, otherwise I’d just veto everything,” so time will tell how Trump ultimately responds.
Contrary to popular opinion, a congressional flip does not always hurt markets. History does not support the view that a double flip is bearish for stocks or automatically disinflationary. In each major wave election of the past three decades, subsequent economic and market outcomes were driven far more by the business cycle, labor market, inflation trends, and Federal Reserve policy than by the partisan makeup of Congress (Figure 2).
Following the 1994 Republican wave, as Figure 2 shows, inflation remained relatively stable, unemployment ticked down, and the S&P 500 delivered large returns. During this period, the market saw a soft landing, while the economy experienced accelerating productivity growth and the early stages of a technology boom.
Likewise, the blue wave in 2006 neither caused nor prevented the downturn two years later. While Democrats captured both chambers of Congress during Bush’s presidency, the subsequent economic outcome was dictated by factors already in motion—namely a Fed tightening cycle, elevated housing market leverage, and growing financial imbalances. Inflation initially accelerated due to commodity price shocks, before collapsing during the financial crisis.
Finally, the red wave in 2010 occurred during Obama’s presidency and the early stages of the post-financial crisis recovery. Despite high unemployment, inflation remained under control; the Fed was also engaged in extraordinary levels of monetary easing. Equities responded favorably, and the S&P 500 gained 15.1% in 2010 and continued to advance over the next two years, as markets stabilized.
The common thread across these three examples is that monetary policy and the broader economic cycle were the dominant drivers of market performance, rather than Congress. Congressional elections may influence specific sectors, legislation, and regulatory priorities, but they rarely alter the trajectory of the economy on their own. In fact, periods of divided government have often coincided with strong market performance, as political gridlock can limit major policy changes.
Returning to the present, the October jobs report, printed last Friday, surprised markets to the upside by painting a strong picture of the U.S. labor market. Nonfarm payrolls increased by 165,000 jobs, more than double the consensus estimate. The largest increases were in healthcare and professional sectors. September’s figure was also revised up from 29,000 to 60,000.
Private payrolls increased dramatically too, from 78,000 in September (itself revised up from 46,000) to 159,000 for October. Average hourly earnings jumped by 0.4% month over month and by 3.1% annually. And the unemployment rate ticked down to 4.1%. Following the data release, federal funds futures moved up to a 78% probability of a rate hike in December.
The historical record suggests that economic and market outcomes following major political realignments have been driven primarily by the Federal Reserve’s policy stance rather than the partisan composition of Congress. Whether following the 1994 Republican wave, the 2006 Democratic wave, or the 2010 Republican wave, subsequent inflation, unemployment, and equity market performance largely reflected the prevailing monetary policy cycle. Indeed, the federal funds rate—which has ranged from nearly 8% in 1990 to effectively 0% during the financial crisis and pandemic (Figure 3)—typically exerts a much stronger influence on markets than do changes in the party that controls Congress.
In short, the consequences of the 2026 midterms are likely to be isolated more toward the political spectrum than economic; the shift to divided government may cause more political angst or constrain future fiscal initiatives and increase oversight activity of the executive branch. But the trajectory of the U.S. economy will depend far more on the path of monetary policy—Congress has turned blue, but Wall Street will still focus on the green.
FROM THE DESK
Agency CMBS — It was a relatively quiet week in our market, as is typical for the beginning of the month. Total volume for the week was roughly $547 million, down 9% from the previous week and down 12% from the trailing average. Fannie spreads tightened one basis point (bp) but otherwise remained flat. Ginnie Mae spreads widened at the end of the week by four to five bps on large supply (about $550 million) and ongoing weak demand from Ginnie REMIC buyers.
Municipals — AAA tax-exempt yields moved lower across the curve for a fourth consecutive week; rates declined 10 to 15 bps across the intermediate and long end. Municipals entered the week with positive momentum following a strong October, the market’s best monthly performance since late 2023. Lighter primary issuance provided a supportive technical backdrop, allowing investors to put cash to work without the concession pressure that characterized September and early October. Fund flows moderated, however, with municipal funds seeing just $287 million of inflows after several weeks near the $1 billion mark; high-yield funds experienced $54 million of outflows.
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