Atlantic Crosswinds: Europe After the US Midterms

Comparing the US Elections with European Implications

With the results in, the breadth of the Democrats victory in the US midterm elections is striking. Ron Desantis, the outgoing governor of Florida, defined it as: “Close to an extinction-level event for Republicans.” In the United Kingdom, we have seen something similar with the rout of the Tory party in 2024. The question is whether the Democrats can make a better fist of things than Kier Starmer did.

The cost of living was a defining election issue, encompassing housing, health care, energy and everyday expenses. And the blame for that was firmly put on President Donald Trumps’ decision to attack Iran. As the riots continue in France and have spilled over into Germany, this is the key issue in Europe and incumbents are being blamed. Inflation is seen as destroying living standards, and the weakening of the Trump presidency is seen as a precursor to a settlement that may reopen the Straits of Hormuz. As one commentator put it, “the USA may not want to pay for Europe’s defence, but Europe is paying for their war.” This will embolden both Iran and the Europeans in their dealing with the United States.

The question for Europe is who else is there to speak to in the US as the presidency enters its last two years. In this case, NATO will become the key defence forum, and given there is no resolution in the Russia-Ukraine war, the pressure to raise defence spending will likely continue. In Europe, the concerns over second-round inflation are the greatest, evident in the European Central Bank’s move to raise interest rates early, and it was the driving force behind the rise in rates from the Bank of England. Central banks are clearly prepared to do more, so this is an issue that will not go away, at least until next summer. The UK consumer will see a rise in the domestic energy bills of at least 20% in January—and a cold snap would make it worse. 

AI infrastructure is becoming increasingly political in the United States, and data centres are contributing to concerns over electricity prices, water consumption and infrastructure costs; the same concerns are in Europe, but with a strong regulatory overtone. The election is unlikely to reverse structural demand for AI, but federal state governments could increasingly influence where facilities are built, how rapidly projects proceed and who pays for supporting infrastructure. There may be a case for moving some of these investments to international locations, regionalising compute. It would be welcomed by European governments who are concerned about the security implications of over reliance on the United States post the Starlink restrictions in Ukraine. Power generation, transmission and electrical equipment should remain important investment opportunities, although developers may face greater regulatory costs and thus delays. It seems their stock prices have welcomed a slowing of the frenetic pace.

Sector dispersion could increase. Health care faces scrutiny over drug prices, insurance and reimbursement; financial institutions may encounter tougher congressional oversight; and defence and energy companies remain sensitive to changes in spending, regulation and permitting. This would continue the trend that is already in place in Europe.

US political gridlock need not be bad for markets, however. Is it gridlock—or opportunity unlocked? Franklin Templeton Institute research, covering the nine midterms from 1990 through 2022 found that the S&P 500 Index gained an average 14.5% in the 12 months following a midterm election, with positive returns after every one of them.¹ But gridlock should not be confused with a new fiscal discipline. Large deficits and substantial Treasury issuance remain, making real interest rates particularly important for equity valuations, housing and infrastructure investment. Should an event occur that needs significant fiscal response, does any country have the flexibility to respond? Europe’s fiscal position, with the exception of Germany, is equally parlous, if not more so. There is even less room for manoeuvre, should circumstances require

A more constrained Trump presidency may not mean less uncertainty. Legislative gridlock could encourage greater reliance on executive authority over tariffs, trade, immigration, sanctions and foreign policy. Given how large tariffs are becoming in the overall revenue stream of the US government, it is hard to see them disappearing, whomever is in power.

Europe has had a series of good earnings reports against a weakening economic backdrop, driven by higher interest rates. The European political cycle starts with the Spanish elections at the end of November, and these themes will play out there as well as in France in the spring and perhaps in the United Kingdom as well. Incumbents will not benefit, but there is a growing certainty to this cycle. It may be slowed by the current interest-rate rises, but that also means prolonged. Earnings growth, real interest rates and the sustainability of the AI investment cycle remain the bigger drivers of long-term returns.