A lame-duck Trump confronts inflation, markets and gridlock

By Nathan Brooks

Democrats won control of both the US House and Senate in the midterms, leaving President Donald Trump a lame duck with two years in office and less power over domestic policy. Analysts said the prospect of an erratic lame-duck presidency would carry significant implications for financial markets, growth, inflation, government borrowing costs and living standards.

The immediate shift is gridlock. Investors also fear that Trump may adopt a more aggressive foreign-policy line as domestic control weakens, potentially intensifying the war in Iran and reviving energy-price pressure.

What does this change for households and businesses?

It raises the risk of higher fuel bills, borrowing costs and weaker investment. For US households and small businesses, those effects matter more than the congressional arithmetic. The deeply unpopular war had driven surging inflation, while a chaotic tariff policy devastated small businesses. Together, those pressures were key to the midterm result.

US diesel prices hit a record high in August, while headline inflation rose to 3.7%. The US-Israeli invasion of Iran closed the critical Strait of Hormuz and reignited global inflation pressures, producing what analysts describe as the biggest energy price shock of the modern age.

Oil offered a brief reprieve on Wednesday. Brent crude, the international benchmark, fell as much as 9% to trade below $100 a barrel for the first time in a month and sat near $94, well above its prewar level of about $70. Investors linked the decline to the election result and hopes for a diplomatic breakthrough in Iran.

The International Monetary Fund expects global headline inflation to rise to 4.7% this year, with energy-importing countries hardest hit. Analysts say a Trump escalation against Iran would add to that inflationary shock, though it could deepen his unpopularity.

Markets test the “Mr Veto” scenario

Asian stocks initially fell in early overnight trading, then rallied as investors weighed the midterms. Investors generally dislike uncertainty and political chaos, and they took Trump's concession of defeat and acknowledgment of the Iran war's impact as positives. His warning that he will become “Mr Veto” nevertheless points to a turbulent final phase.

Holger Schmieding, the chief economist at Berenberg, said the result showed that US voters had “rejected Trump and his somewhat authoritarian penchant for crony capitalism. [That] shows that US institutions and its checks and balances work. That is a positive, in my view.”

The outlook for stocks, inflation and growth now rests on two variables: the Middle East war and the pace of AI advancement. Traders expect Democrats to take a tougher line on AI regulation and datacentre rollout, putting a major driver of stock-market growth under scrutiny. They also fear Trump may pursue a more aggressive foreign policy and intensify the Iran conflict.

Inflation forces central banks to tighten

Higher inflation has forced central banks to raise rates. The Federal Reserve defied pressure from Trump by raising borrowing costs for the first time since 2023. Investors expect at least one more increase as the war and inflation keep the backdrop volatile.

The Bank of England was expected on Thursday to raise rates, while the European Central Bank was also expected to increase borrowing costs. Those moves would follow the Federal Reserve's renewed tightening and add pressure on borrowers across major economies.

Republicans now lack the votes to confirm appointments to critical public bodies, including new Fed governors. Trump retains his veto power, which can be overturned only with two-thirds agreement in both chambers. That narrows his influence over the central bank as inflation rises.

Higher inflation and interest rates caused by the Iran war have increased borrowing costs, adding pressure to heavily indebted countries. In the US, the logjammed political system faces its first major test on 11 November, when lawmakers must authorize government spending to avert a shutdown.

Gridlock could prevent Trump from launching new tax and spending measures. The restraint could limit fiscal stimulus for growth, but it could also cap further increases in borrowing and debt. Analysts also expect the heavy midterm defeats for Maga candidates to weaken the president's authority and open the way for more Republican-Democratic cooperation.

AI becomes the next growth fault line

Political turbulence and Trump's actions on trade and immigration could put US growth at risk, although inflation and Middle East de-escalation are the main factors to watch. A Democratic clampdown on AI could deter investment and slow growth, even as AI spending has supported the UK economy.

Tech-industry leaders were already cooling the rollout of AI because of cyber-risk concerns. Some investors also fear a bubble in the US stock market. Allianz analysts said AI's investment scale and capacity to power global growth could make the left-right political playbook less predictable than in the past. Environmental and social impacts are becoming more important to that debate.

The International Monetary Fund forecast last month that US growth would remain stable at 2.3% this year and next. The projection already carried risks from the Iran war and an uncertain AI investment path. Berenberg economists see US growth slowing to about 1.5% in 2028 because of political gridlock, an AI slowdown and Trump's crackdown on immigration. They expect the US to contribute less to global growth than before.

For businesses planning investment, the watchlist now runs from oil near $94 and the 11 November spending vote to Fed appointments and AI regulation. Those signals will show whether congressional gridlock damps volatility or deepens the economic shock.