Investors expect a blue wave in next week's midterm election, as Democrats surge in polls and President Donald Trump's approval rating remains low.
Public polling suggests Democrats are likely to take control of the House of Representatives, and analysts who parse what politics means for investors are in overdrive to tell their clients how to prepare for what Congress will look like after the Tuesday election.
Concern about the spending plans and priorities of a Democratic-controlled Congress permeates analyst reports reviewed by CNBC. But because Trump has another two years of his presidency, a divided government would likely create gridlock that would prevent congressional leadership in opposition to the president from getting much done, analysts are advising their clients.
Most analysts believe Democrats are also within striking distance of a Senate majority, though that outcome is significantly less likely than a House flip according to the polls. Next Tuesday's elections will determine which party controls both chambers of Congress for the remainder of Trump's presidency, after two years of full Republican control.
Divided government typically makes must-pass legislation, like government funding and raising the debt ceiling, harder to enact. A debt ceiling standoff — or first-ever default on federal debt — could be particularly damaging.
Wall Street watchers are also expecting Democrats to try to advance an ambitious and expensive agenda should they gain control of Congress. An Oct. 29 report from Piper Sandler analyzing Congressional Budget Office data projected that policy proposals from Democrats "would add $5 trillion to the deficit over the coming decade." The analysis assumes repeals of Trump's tariffs and reversing cuts to Medicaid, nutrition programs and Affordable Care Act subsidies.
Major policy swings — and big spending packages — become less likely as a divided government is unlikely to agree on issues. That's a dynamic the market typically enjoys. Trump's veto power would effectively block major Democratic policies from becoming law.
"A blue House is the obvious consensus base case," Wolfe Research said in an Oct. 27 report. The firm surveyed 138 investors and found 96% of those polled believed Democrats would prevail in House control.
"The scale of polling error that would be required for Republicans to retain House control would be unprecedented in modern history, well above the polling error in the famously bad 2020 cycle," Wolfe wrote.
Wolfe is less bullish on a Democratic Senate, though investors clearly see a possibility that Democrats regain control of both chambers of Congress.
Fifty-eight percent of investors the firm surveyed believed Democrats would gain control of the Senate, while 42% believed Republicans would retain control of the chamber. The investors surveyed were more bullish than Wolfe itself, which puts the chances of a Democratic Senate at 49%.
Other analysts are largely coalescing around the potential for a good night for Democrats.
"A blue wave scenario has become our base case," an Oct. 20 report from TD Securities reads. An Oct. 23 Raymond James report says "Democrats are in a solid position to win a majority in the House of Representatives and are increasingly likely to win enough seats to capture a Senate majority."
Even if Democrats sweep both chambers, protracted battles could still play out as Republicans maintain the White House and the Senate must still surpass the 60-vote filibuster threshold.
Democrats winning control of the Senate could allay concerns about the Federal Reserve's independence from Trump, TD predicted.
That's because any new Fed members would need to be confirmed by the Senate, which would be unlikely to support a nominee who wouldn't support the central bank charting its own course.
Democrats are also expected to investigate companies that have done business with the Trump administration should they win control of a chamber. The majority party in Congress holds subpoena power on committees. Some Democrats have already telegraphed their investigative priorities ahead of the election.
The debt ceiling is likely the most critical sticking point for the economy that lawmakers will need to address during the next Congress, unless Republicans raise it during the lame-duck session between the election and the start of the next Congress in January. The Bipartisan Policy Center expects the U.S. will reach the so-called X-date — the point at which Treasury runs out of cash under the debt ceiling — between late-winter and mid-summer 2027.
"While negotiations around the debt ceiling may come down to the wire, a Democratic Congress would make it slightly more likely that a bill is passed than a divided Congress," TD said.
If Congress does not raise the debt ceiling by the X-date, the U.S. could default on its debt, causing catastrophic economic consequences.
Democrats, should they control one slice of government, are expected to demand concessions from Republicans in exchange for their votes to raise the debt ceiling. That sets up a potential standoff, which analysts note Republicans could avoid if they lose next week and raise the debt ceiling during the lame duck.
"[R]aising the debt limit before January could substantially reduce leverage Democrats have over healthcare, Medicaid, SNAP, and broader domestic spending priorities in the next Congress," Raymond James told its clients.