From Washington to Brasília, elections have markets doing the math and debt

Elections across major economies are putting fiscal policy and sovereign debt risks in focus for investors, with political outcomes in the U.S., Brazil, and France carrying differing implications for government spending, economic growth, and borrowing costs, Morgan Stanley Chief Global Economist Seth Carpenter said.

Carpenter said the U.S. midterm elections this week are unlikely to produce a significant shift in the federal government's macroeconomic policy stance, with polls pointing to a divided government.

Tariffs, trade, and immigration policies are largely within the executive branch's authority and are unlikely to change materially with a shift in congressional control, he said.

A sufficiently large change in House and Senate majorities could, however, lead to the reversal of some domestic spending cuts, providing a modest boost to growth, while potentially restraining military spending and offsetting some of that support, Carpenter said.

Because federal AI policy is not expected to change materially, the results are likely to offer only a hint of state and local involvement in permitting, grid access, and electricity pricing.

Brazil's recent election has triggered market volatility as investors reassess the country's fiscal outlook following Luiz Inácio Lula da Silva's victory.

Last week, Brazilian stocks plunged after Silva secured a fourth term in Sunday's presidential runoff, defeating right-wing challenger Flávio Bolsonaro and overturning market expectations of a shift toward more conservative economic policies.

However, Morgan Stanley said meaningful fiscal adjustment would remain difficult regardless of the election result, as more than 91% of government spending is mandatory and changes require congressional action.

The bank expects Brazil to face a moderately restrictive credit cycle next year, a risk it suspects markets have not fully priced in. The election may affect specific fiscal policies but has not fundamentally changed the country's underlying economic risks, Carpenter said.

In France, attention is turning to negotiations over the 2027 budget, expected in late November and December, amid elevated borrowing costs and political uncertainty ahead of elections next year. Current proposals would only stabilize the deficit, while higher taxes could weigh on growth and spending cuts risk slowing economic activity, Morgan Stanley said.

The bank also flagged the possibility of election-related volatility spreading to Spain, Greece, and Italy in 2027, potentially widening turbulence in sovereign debt markets. Broader financial friction could prompt a European Central Bank response, although Morgan Stanley does not include that outcome in its baseline outlook.

While the economic implications of the U.S. midterms remain limited or unclear, fiscal consequences elsewhere are likely to be greater, Carpenter said.