Although the conflict in Iran keeps dominating the news cycle, investors have an eye on the upcoming U.S. midterm elections. Our Deputy Global Head of Research Michael Zezas and Head of Public Policy Research Ariana Salvatore consider policy implications – from healthcare and consumer to AI.

Read more insights from Morgan Stanley.

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Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Deputy Global Head of Research for Morgan Stanley.

Ariana Salvatore: And I'm Ariana Salvatore, Head of Public Policy Research.

Michael Zezas: Today we're discussing the midterm elections and their implications for U.S. markets.

It's Wednesday, April 22nd at 10am in New York.

All right, so Ariana, midterm elections are coming up. And I feel like every cycle we hear the same question. How much do elections actually matter for markets?

Ariana Salvatore: Yeah, I would say, you know, we're still six months out and obviously a lot of the market's focus has been on the U.S.-Iran conflict. But it does keep coming up in our conversations with investors.

And to your question, our view is these elections probably matter a little bit less than people think, at least from a macro perspective.

Michael Zezas: Okay, so that seems a bit counterintuitive, right? Because policy has felt like a huge driver of markets recently. Tariffs. Geopolitics. Really all the above.

Ariana Salvatore: Exactly. But there's some nuance here. So, policy does matter, but the big takeaway is that the direction of policy doesn't really change based on the midterms. That's because some of the key policy variables that you mentioned – trade, geopolitics, also deregulation – those are all likely to keep going regardless of who wins.

At the same time, it's worth noting upfront that the race itself is still pretty fluid. A lot of the indicators that investors are watching – polling prediction markets, the president's approval rating, even things like domestic gasoline prices and consumer sentiment – they're somewhat giving mixed signals right now. There's a growing narrative around a potential democratic sweep. But when you actually look in more detail at the Senate map, we think the path there is still pretty challenging.

So, I think it's important to emphasize there's much more uncertainty in the outcome than the headlines right now might suggest.

Michael Zezas: So, if those indicators end up being right and we do in fact see a divided government, what do you think investors should be paying attention to?

Ariana Salvatore: There are some incremental shifts that will be worth watching. In particular as they pertain to fiscal policy. So, for example, things like SNAP and Medicaid, those are the real swing factors depending on the election outcome.

If you recall last year, the One Big Beautiful Bill Act legislated some changes to those programs that are meant to start taking effect in 2027 and 2028. Things like shifting more of the cost burden onto states and tightening eligibility requirements to offset some of the deficit impact from tax cuts.

And where elections come in is around whether or not those changes actually get implemented or delayed or softened. In our view, the most likely way you can get meaningful adjustments is in some form of divided government where there actually might be an incentive to negotiate around those fiscal cliffs.

But crucially, we think that can only happen if you have what we call a robust rather than a fragile majority.

Michael Zezas: Okay. Can you explain the difference between those two things?

Ariana Salvatore: Yeah. So, the question is not just who controls Congress, it's how unified they are. If you get a robust majority, that means the party can agree internally on what their core policy objectives are. And then use their leverage in a cohesive way to extract political concessions from the opposing party.

So, to put it in simpler terms. If Democrats have a large enough majority or are able to coalesce around some of the key policy asks – for example, delaying some of these cuts – we think they can tie those two, some must pass bills. Think appropriations bills or debt ceiling extensions, for example, that they will need to be consulted on in a split government scenario.

Now conversely, if it's a fragile majority, you probably see more internal disagreement, less coordination, and a lot more political noise with less actual policy getting done.

Michael Zezas: Okay, so a lot of good insights there. Can you boil it down to a few key takeaways for investors?

Ariana Salvatore: Yeah, so one I would say is that fiscal policy is really where the midterm elections might matter the most. But even there, we think the impact is more micro than macro. Another is that divided government doesn't necessarily mean less policy activity. It just changes the form that it takes. And then of course there's AI, which is a topic that we've been getting a lot of questions about.

Michael Zezas: Yeah, so let's dig in a bit more there because there's obviously a lot of interest in the intersection between public policy and the development of artificial intelligence.

Ariana Salvatore: Yeah. This was the key focus of our policy symposium that we hosted in New York last week. AI is increasingly viewed as a strategic priority across both parties. So, unlike some of these fiscal debates, we think that AI policy is likely to take shape regardless of the election outcome. What could change is the approach.

So, think about things like how quickly infrastructure gets built, how permitting is handled, how energy constraints are addressed. We're seeing growing recognition across the aisle that the bottleneck for AI isn't just on the innovation front, it's the physical infrastructure – power, data centers and supply chains.

Now at the same time, there's also emerging pushback from communities and from policy makers around things like energy usage and cost of living. We've done a lot of research on this front, and it's actually a really critical factor in some of these off-cycle elections that we've seen even back to last year.

So, you end up with this dynamic where AI investment probably continues both in a more constrained and increasingly regulated environment in the split government scenarios.

Michael Zezas: So, direction's the same, but the pace and the friction points may vary. And that has implications in particular for a few key sectors like power and data center REITs, while consumer and healthcare sectors are more exposed to those SNAP and Medicaid changes we mentioned earlier. Obviously the more unified Democrats are, the more they're able to extend or push off those shifts. Meaning the downside impact on the consumer could be limited versus current expectations.

But aside from these policies we're watching. You'll probably see noise around debt ceiling fights, government shutdowns. And those things don't usually derail growth. But they can create volatility and short-term uncertainty, especially around funding deadlines.

Ariana Salvatore: Right. And that's important for the macro-outlook. So, in short, our economists think that the growth outcomes are only going to vary modestly across the scenarios while the broader business cycle should stay intact.

Now, following from that, our rate strategists see episodic risk, to your point around funding fights, which could drive risk off rallies in notes and bonds. And then you have to weigh that against cooling expectations for growth and inflation in both the divided government scenarios. Similarly, our FX strategists see opposing forces between yields, fiscal policy and the broader policy uncertainty variable driving dispersion across currencies more than a clear dollar direction.

Michael Zezas: Got it. So, a lot to pay attention to ahead of the midterms and we'll obviously keep people updated here about what we're seeing.

Ariana Salvatore: Sounds good.

Michael Zezas: Ariana, thanks for taking the time to talk.

Ariana Salvatore: Great speaking with you, Mike.

Michael Zezas: And as a reminder, if you enjoy Thoughts on the Market please take a moment to rate and review us wherever you listen. And share Thoughts on the Market with a friend or colleague today.