A landslide Democratic victory in the U.S. midterm elections could limit interest rate hikes globally next year, market watchers say, but oil prices, U.S. economic growth and the uncertain path of fiscal policy will be key.
Central banks around the world are back in tightening mode, with the Federal Reserve, Bank of England, European Central Bank and Bank of Japan raising interest rates in recent months.
Part of this shift is due to the U.S. and Israel’s war with Iran pushing up prices in the oil and gas market. The war has also exacerbated the strain on global refining capacity, driving up prices for products such as diesel, gasoline and jet fuel.
Traders had largely predicted a significant Democratic victory this week after polls showed them in their favor, but the party’s control of both chambers of Congress remains uncertain before the vote, raising the possibility that lawmakers will challenge President Donald Trump’s policy decisions.
Oil prices fell following clear Democratic victories in both houses of Congress, leading to international benchmarks ICE brent crude oil It fell 8.7% on Wednesday, closing below $100 a barrel for the first time since September.
ICE Brent crude oil.
This was mainly due to expectations that this outcome would make President Trump more likely to reach a deal to end the war with Iran, which would restore production capacity at Gulf refineries and improve export conditions. Vice President J.D. Vance’s lengthy statement condemning the Republican Party’s losses from the Iran war reinforced that view.
“Despite the Republican Party’s admission that they lost the election due to the Iran war, the market view is that a quick resolution to the Middle East conflict will help the party save face,” said Dan Coatsworth, head of markets at AJ Bell.
“President Trump may relish the opportunity to take all the credit if the end of the war brings energy costs down significantly.”
Andrew Slimmon, senior portfolio manager and head of applied equity advisors at Morgan Stanley, said the election results “could lead to lower oil prices if they encourage a resolution to the Middle East conflict. That’s a problem for the Fed and inflation, and that’s one of the reasons interest rates are rising.”
Ralph Axel, interest rate strategist at Bank of America, said in a research note published Thursday that historical data shows a close correlation between oil prices and global interest rates. Rising oil prices over the next three to six months are likely to mean “significant increases in interest rates” in the US, but especially in the UK and Germany, he said.
“We believe that if oil prices rise, interest rates will rise as well. Especially on the front end, the long-term premium is not as important a factor and monetary policy expectations play a bigger role,” he added.
There’s no way out for Republicans
As Thursday’s rise in oil prices and Friday’s instability showed, a resolution to the nearly nine-month-old conflict is still far from settled.
“So far, oil prices are starting to rise again and interest rate expectations are unchanged from pre-election levels,” said Dan Coatsworth of AJ Bell.
Money markets on Thursday showed a modest change in expectations from a week ago in both the U.S. and Europe, with traders pricing in a slightly higher chance of a year of monetary easing.
The impact on the two-year horizon was more pronounced in the euro zone than in the US, with weekly interest rates cut by 8.7 basis points by the ECB and 4.6 basis points by the Fed, according to CNBC, which analyzed LSEG data.
“Republicans have no way out at this point,” said Laurel Rupp, director of Chatham House’s U.S. and North America program. “We know that Democrats will seek votes in both houses of Congress to keep Republicans in check and restrain the administration on Iran’s war powers. But whether that will constrain the administration is another question.”
Meanwhile, Eurasia Group’s Clayton Allen told CNBC’s Squawk Box Asia that while a war with Iran is unpopular domestically, leaving the region without a tangible victory is also unpopular, and he expects the war to escalate in the coming weeks.
Bank of England Governor Andrew Bailey, who raised interest rates by 25 basis points on Thursday, told CNBC that energy price pressures are coming from a combination of obstacles in the Strait of Hormuz, a lack of refining capacity and a lack of gas storage in Europe.
“The Middle East peace process is not going to change all of these factors,” he told CNBC’s Steve Sedgwick on Thursday.
“Let’s wait and see, because we’ve seen energy prices fall in the last 48 hours. But as we’ve seen over the last seven, eight, nine months, the situation is very volatile.”
Ken Egan, head of European sovereign credit at KBRA, said the interest rate outlook will be primarily influenced by whether there is enough underlying momentum in the economy to further sustain existing inflationary pressures.
He said in an email that Europe is “entering winter after months of high energy prices, the effects of which are still reverberating throughout the economy.”
“The concern for central banks is whether these pressures will start to push up wages and prices more broadly, or whether weak demand will limit their transfer.”
Growth outlook
Jane Foley, head of currency strategy at Rabobank, said in an email that the key question for the Fed is whether a blue sweep “could encourage more fiscal prudence in the U.S. and, in turn, reduce inflation.”
“However, it is very early to be confident about the fiscal outlook, especially since many Democrats voted to ease cost-of-living pressures. So it is very difficult to draw firm conclusions at this point about how the interest rate outlook will change next year,” he said.
James Sullivan, managing director and head of Asia-Pacific equity research at JPMorgan, told CNBC’s “Squawk Box Asia” that the high level of fiscal stimulus in the U.S. and whether that is about to change is now a “million-dollar question.”
“The reason inflation remains high is due to a combination of factors, from the Iran war to tariffs to significant tightening in certain sectors of the energy complex,” he said.
“However, it is also important to recognize that the U.S. government remains committed to an expanding economy with very high levels of spending and low unemployment, which has very specific macroeconomic implications. If that changes, it could take pressure off the interest rate environment in a way that gives the Fed significant positive flexibility.”
Daniel Clifton, director of policy research at Baird Strategas, said the impact on U.S. data center expansion is also a big factor to watch.
“There was a big fiscal headwind in 2025, but it didn’t really matter because last year we had such a big capital investment boom in building AI. This year was really driven by the stimulus,” he said on CNBC’s “Squawk Box Europe.”
“If we are in a tightening fiscal policy environment (the Fed is currently raising rates) and the growth in AI capital spending slows, we will likely see a policy error at some point in mid-2027,” he said.
“This is what happened in 2000, during the 2000 technology boom. The Fed raised interest rates, oil prices went up, they went too far and we ended up in a recession. Our projection is not that the U.S. will go into a recession. Our projection is a mid-cycle slowdown in 2027.”
