US fiscal deterioration emerges as key investor worry ahead of midterm elections

The deteriorating fiscal position of the United States is emerging as a major concern for investors ahead of the November midterm elections, with rising national debt, persistent budget deficits and mounting interest payments expected to keep pressure on financial markets.

The US national debt has crossed $40 trillion, while the federal budget deficit is projected to remain around 6 per cent of gross domestic product (GDP), equivalent to approximately $2 trillion this year. Investors fear that continued borrowing and rising government debt issuance could weaken confidence in US Treasury bonds and increase financial market volatility.

The election outcome is unlikely to bring a significant improvement in the country’s fiscal position. A Republican victory would largely preserve existing spending and tax policies, while a Democratic takeover of Congress could introduce greater political gridlock without necessarily delivering substantial reductions in government borrowing.

Prediction markets Kalshi and Polymarket have indicated that Democrats have a strong possibility of gaining control of both chambers of Congress. A recent Reuters poll also showed an 11-point advantage for Democrats, although some financial institutions expect a divided Congress, with several Senate races remaining closely contested.

A Democratic victory could constrain additional tax cuts and limit increases in discretionary spending. However, structural expenditure pressures, particularly rising costs associated with Social Security, Medicare and interest payments on outstanding debt, are expected to continue driving government borrowing.

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The fiscal outlook is also being complicated by the growing cost of servicing existing debt. With interest expenses rising alongside the national debt, the government faces increasing pressure to finance its obligations even without introducing major new spending programmes.

A change in congressional control could have mixed implications for US financial markets. A Democratic majority could potentially moderate spending growth by forcing greater political compromise, offering some support to longer-dated Treasury bonds.

Long-term Treasury yields are particularly sensitive to expectations surrounding government borrowing, inflation and fiscal sustainability. Any slowdown in the pace of additional spending could therefore improve investor sentiment towards government bonds.

The dollar could also receive some short-term support if a Democratic victory reduces uncertainty surrounding the Trump administration’s fiscal, trade and foreign policies. Lower political uncertainty could reduce the additional risk premium investors demand to hold US financial assets.

However, expectations of higher government spending remain entrenched under both possible election outcomes. The prospect of increased expenditure, combined with limited political willingness to undertake major fiscal reforms, means the budget deficit could continue expanding.

Debt ceiling emerges as another market risk

Beyond the election outcome, investors are increasingly concerned about the possibility of renewed political clashes over the US debt ceiling and government funding.

A divided Congress could make negotiations more difficult as Republicans and Democrats attempt to secure concessions on spending priorities and tax policies. Such disagreements could increase the risk of a prolonged government funding standoff and inject fresh uncertainty into financial markets.

Congress has postponed contentious discussions over fiscal 2027 spending until after the midterm elections, with December 11 set as the deadline for reaching a government funding agreement.

Although the next debt ceiling deadline is not expected until late 2027, Democrats could use the approaching borrowing-limit negotiations as leverage to seek concessions on spending and taxation.

Historically, Republicans have positioned themselves as advocates of fiscal conservatism, emphasising lower taxes, smaller government and spending restraint. However, these policies have not consistently translated into lower federal deficits or a reduction in national debt.

Ultimately, investors expect the US fiscal position to remain a significant source of uncertainty over the next two years. Regardless of which party controls Congress, narrow political majorities and entrenched spending commitments are likely to limit the scope for transformative fiscal reforms.