Democrats Sweep Congress! Morgan Stanley Emergency Redraws Trade Map: Overweight Stocks Remain, AI Data Centers Become the Biggest Losers

According to The Zhihui Finance APP, Morgan Stanley stated in its latest research report that the Democratic Party has secured control of both the House and the Senate, although some election results are still being counted. This decisive election outcome indicates that the situation is moving toward what the bank envisioned as a “Democratic unified majority” scenario. In this scenario, uncertainties brought by a change in governance could serve as a headwind for overall stock market performance, similar to the market volatility triggered after the Republicans gained control of the House following the 2022 midterm elections. However, cuts to SNAP (Supplemental Nutrition Assistance Program) and Medicaid are likely to be delayed, which would benefit consumer sectors and pose some upside risk to economic growth forecasts.

Morgan Stanley noted that the path for each party to push budget reconciliation bills strictly along party lines has now been closed, eliminating a major upside risk to the US Treasury’s financing needs. Although delaying cuts to SNAP and Medicaid could have the opposite effect, their impact is likely to be small relative to the $2 trillion fiscal deficit.

Policy bargaining is likely to focus more on short-term issues, as the Democratic majority is able to build consensus around policy demands, leveraging the December government funding deadline and the 2027 debt ceiling as bargaining chips.

In terms of major market impacts, with expectations for data center restrictions heating up, sentiment around the AI sector could be further negatively affected. However, Morgan Stanley believes the new adverse effects will be specific to individual regions and will not alter the overall narrative around AI capital expenditure. Its base case assumes AI-related capex will remain stable. Meanwhile, the bank maintains its overall outlook for resilient economic growth and continued gradual easing of inflation.

In the foreign exchange market, Morgan Stanley expects short-term trading to remain consistent with its defensive market scenario, where the yen, Swiss franc, and euro strengthen against the dollar. Adverse factors related to AI may cause the Australian dollar to underperform in cross rates, while targeted tariff risks may put pressure on the Canadian dollar relative to lower-yielding currencies. Stronger congressional resistance to renewed geopolitical escalation could also put downward pressure on the NOK/SEK exchange rate.

Possible Policy Paths

Four key areas need to be focused on:

1. Fiscal Policy. Morgan Stanley expects that the measures to cut SNAP and Medicaid spending in the "One Big, Beautiful Bill Act" (OBBBA) could be revoked, delayed in implementation, or relaxed during negotiations over fiscal policy deadlines. The Democratic Party is likely to have a sufficient majority to reconcile internal differences and build consensus around a few policy priorities. Overall, even if these cuts are delayed, the bank still believes the US fiscal deficit will remain at around 6% of GDP.

2. Executive-Dominated Policy. Morgan Stanley believes that since the start of President Trump's second term, policy uncertainty has mainly stemmed from executive branch actions rather than legislative action. Policy aspects such as tariffs, geopolitics, trade (especially the review of the USMCA), deregulation, and export controls are expected to continue, so policy uncertainty should remain at a certain level.

3. Data Center Restrictions. Morgan Stanley notes that the real risk lies in state-level regulations promoted by newly elected officials, which may further divide the US—some regions may be open to new data centers, while others may prohibit such projects. Key levers that truly constrain projects, including grid connection, large-load electricity pricing design, site selection, and tax incentives, are almost entirely in the hands of state regulatory commissions, state legislatures, and county-level commissions. Therefore, power shifts in some gubernatorial seats are worth close attention, though related effects could be limited to specific jurisdictions.

From the perspective of data center development, the most important result of this election is undoubtedly the Texas gubernatorial election. In Texas, Democrat Gina Hinojosa won the governorship, increasing policy risks related to data center approval and construction progress. Gina Hinojosa’s campaign platform includes suspending approvals for new data center projects. Given that the Texas governor can participate in approving new data center projects through multiple regulatory agencies, Morgan Stanley believes many projects may face substantial delays.

4. Signaling for the 2028 Election. Morgan Stanley has always held that the midterm results should not be directly extrapolated to the 2028 presidential race. However, the next two years will serve as a window for lawmakers to lay the groundwork for federal policy actions in 2029 and beyond, provided the presidential office changes hands. The bank expects that lawmakers may propose legislation targeting AI infrastructure, such as repealing the immediate expensing policy in the OBBBA or taxing compute power. However, given the president’s opposition to such measures, this type of legislation is unlikely to be enacted.

Main Market and Economic Impacts

US Equities. As Morgan Stanley discussed last week, midterms are the most obvious risk event and have now concluded, with historical performance offering encouraging signals. Since 1982, large-cap stocks (market cap weighted) have risen about 15% on average and equal-weighted about 16% in the six months following midterms; over the subsequent year, both measures deliver cumulative gains of roughly 22%.

Morgan Stanley believes investors generally expected the Democratic Party to sweep the elections and secure a slim majority in the Senate. Therefore, given the Democratic victory in the Texas gubernatorial race, the result may increase short-term market volatility. However, the bank also believes this may mark the final stage of the rolling market correction discussed since this summer. After the election, further short-term risks could come from escalated military conflict between the US and Iran or additional US tariffs.

Cross-Asset Allocation. Based on these midterm results, Morgan Stanley continues to recommend overweight global equities and underweight core fixed income assets. The bank’s constructive position on global equities this year has been underpinned by expectations for continued AI capital expenditure cycles. As US tech-related investment is unlikely to shift meaningfully at the aggregate level, the bank expects earnings support across regions, including Europe and emerging markets, to remain intact.

The outlook for the global fixed income market is also largely unchanged. Although enthusiasm about AI-related capex has faded, financing needs for digital infrastructure will keep corporate credit issuance elevated. Heavy issuance may widen credit spreads, especially in lower-quality bonds.

Beyond AI, oil prices and fiscal risks outside the US remain important factors influencing equities, yields, and equity-bond correlations, and deserve as much attention as the US political outlook. The midterm results have not materially changed these factors. Until these factors move, Morgan Stanley’s asset allocation remains unchanged: continue overweight equities and underweight core fixed income assets.

AI Market Sentiment / Capex. Due to the defeat of incumbent officials in key states and local elections, Morgan Stanley believes the election results may most strongly impact AI market sentiment, as local restrictions may become more persistent and wide-ranging. The bank expects new negative effects will be region-specific, not changing the overarching AI capex story, but potentially resulting in greater regional differentiation in the US: some allow new data centers, others don’t.

US Rates. Dual control of Congress by Democrats means Republican-driven budget reconciliation bills cannot proceed after the new Congress convenes in January next year, thus eliminating a significant upside risk to US Treasury financing needs.

Pre-election market pricing had already reflected limited expectations for additional Treasury supply, as prediction markets saw the probability of unified Republican control as low single-digits. This means potential positive effects on swap spreads are likely to be limited.

The new majority may seek to delay SNAP and Medicaid spending cuts at each fiscal policy deadline, which could moderately increase 2-7 year Treasury issuance. Overall, Morgan Stanley believes the belly of the Treasury yield curve is likely to see only modest underperformance.

If the lame-duck session fails to raise the debt ceiling, the Treasury will proceed with plans to increase coupon issuance in February 2027. At that point, Democrats may seek to attach their priorities to the next debt ceiling hike, lengthening the time required to resolve the issue. This may result in weaker prices/higher yields for Treasury bills maturing near the “X date” (the date the Treasury is expected to exhaust extraordinary measures and the cash balance) and make SOFR/fed funds basis trades more attractive by the end of Q3 2027.

Regarding AI, related corporate bond issuance has become a source of duration supply, so the market associates data center construction with 10-year, 30-year Treasury yields and credit spreads. If regional restrictions slow construction, lower AI-related issuance could reduce long-duration supply, potentially raising prices/lowering yields in 10/30-year Treasuries. Morgan Stanley’s base case is for stable AI-related capex—this is thus a risk scenario, not a core forecast. However, changing investor views on scenario probabilities could provide a path for further declines in US Treasury yields.

The Dollar. Morgan Stanley believes the market is pricing in more obstacles for AI-related investment, increased congressional resistance to renewed geopolitical escalation, and higher targeted trade action risk.

In the near term, Morgan Stanley expects FX trading to fit our defensive market view, with the yen, Swiss franc, and euro stronger against the dollar, and the Australian dollar likely to lag in cross rates due to sensitivity to AI-driven equity sentiment, especially after the Democratic win in Texas.

Morgan Stanley also expects the Canadian dollar to underperform low-yield FX as the market prices in rising US tariff risks. In addition, potential political and financing headwinds limiting further escalation in geopolitical conflict may temporarily put downward pressure on NOK/SEK.

US Economy. Morgan Stanley maintains its view for resilient economic growth and continued gradual disinflation. This scenario presents greater upside risks to growth. Delays in SNAP and Medicaid cuts could boost personal consumption by up to 0.4 percentage points in 2027 and accelerate broader spending.

AI-related Financing. The focus of AI financing may gradually shift from power and data center shell financing toward chips. Once projects enter the chip installation stage, data center build and power-up are usually complete—these are precisely the activities most vulnerable to policy obstacles. This shift may keep the credit yield curve flatter.

US Healthcare Services. A Democratic sweep could be viewed as positive by the market for Medicaid-focused managed care companies such as Centene (CNC.US) and Molina Healthcare (MOH.US), while more diversified managed care names—UnitedHealth (UNH.US), CVS Health (CVS.US)—may see only modestly positive market reactions.

The election results grant Congress more room to advance Democratic healthcare priorities, including restoring enhanced Affordable Care Act (ACA) subsidies or rolling back elements of Republican Medicaid cuts, such as work requirements.

While Morgan Stanley still sees little chance for major healthcare policy changes before the next presidential cycle, the result could shift the direction of policy discussion, especially after key backers of Trump healthcare policy/“Make America Healthy Again” (MAHA) have exited.

For Medicare Advantage-focused companies such as Humana (HUM.US), shares may be weak on initial market reaction, as Medicare Advantage is more closely aligned with Republican policies. However, in Morgan Stanley’s view, the effect on Medicaid-related companies should be far more positive.

Lame Duck Session: What Happens Next?

Morgan Stanley is focused on several policy catalysts to watch before year-end:

Government Funding. Congress has already passed a continuing resolution (CR) to keep government funding at current levels through December 11. By then, Congress will have to pass another CR or a full-year funding bill to avert a shutdown.

Democratic leadership has signaled hope to finalize spending bills in the lame-duck session. In Morgan Stanley’s view, this election’s outcome will determine whether leaders extend debate into 2027.

The bank’s past research shows government shutdowns have limited market impact, mostly causing delays to economic releases rather than meaningful downside risks. Earlier policy reports from Washington also cited experts who see a CR potentially continuing through calendar year 2027 (CY27), which remains a risk.

Defense. The baseline is for the Fiscal Year 2027 National Defense Authorization Act (NDAA) to pass by year-end. Notable legislation may be included, such as the MATCH Act (coordinating allied export controls), AI OVERWATCH Act (enshrining chip export policies in law), the Chips Security Act (regarding chip location verification), and the Remote Access Security Act (RASA).

Overall, Morgan Stanley believes policy direction will tighten further, with impetus increasingly coming from Congress, while the administration prioritizes US-China stability.

On the base Defense budget and additional funding, the bank sees the White House’s $1.5 trillion request as aggressive, and will watch in coming months whether budget reconciliation delivers more. OMB director Russell Vought said in early October he was optimistic that Republicans would pass budget reconciliation in the lame-duck session, but Morgan Stanley still expects considerable hurdles for these efforts.

“Budget Reconciliation 3.0”. Outside extra defense funding, the lame duck is the last major window for Republicans to unilaterally pursue a legislative package. Morgan Stanley believes the legislative calendar is tight, with several priorities to address by year-end. However, its rates strategists see this as the principal upside risk for Treasury financing needs.

The debt ceiling could also be handled early via reconciliation, but the more likely scenario is its emergence as a catalyst for H2 2027.

Based on projected financing needs, Morgan Stanley’s rates strategists estimate US public debt will hit the limit in March 2027, when it will start to constrain policy. The “X date”—when the Treasury exhausts all extraordinary measures and cash to meet all obligations—is expected by the end of Q3 2027.

Leadership Elections. Leadership votes will take place soon after the election, with committee appointments at the same time. Tonight’s results mean Democrats will fill all committee chairmanships, usually given to senior members of the former minority.

More broadly, committee roles and vote outcomes reflect future policy direction in each area. For instance, healthcare policy may be influenced by the Health, Education, Labor, and Pensions Committee (HELP Committee).

Permitting Reform. The bipartisan American Affordability and Jobs Act will reform federal environmental reviews and provide greater certainty for approved projects. It will also require data centers to cover transmission costs (effectively turning the “Ratepayer Protection Pledge” from a voluntary promise into a federal mandate). Morgan Stanley notes that, given significant policy disagreement and a limited legislative calendar, passage remains uncertain.

Data Center Restrictions in Focus

Democrat Gina Hinojosa’s win in the Texas governorship could raise policy uncertainty and restrict future data center supply, raising the relative value and pricing power of existing facilities with secured power assurance.

In August this year, after Texas Governor Greg Abbott requested a review of all data center projects in the queue for ERCOT grid connection, Texas suspended some on-grid processes for data centers. At the time, connection applications had reached about 474 GW—over five times ERCOT’s historic peak demand—with data centers accounting for 90% of incremental demand requests.

Abbott warned this scale of development could threaten grid reliability and stability, prompting ERCOT to delay “Batch Zero” transmission planning for the first batch of new large-load projects connecting to the grid. Part of the review’s intent is to distinguish legitimate projects from speculative applications, which may exaggerate Texas's future power demand forecast.

Actions available to the Texas governor include issuing executive orders — temporarily halting new projects pending legislative guidelines. If the Republican-led legislature acts rapidly, this halt may persist only for months.

Appointing members to the Texas Public Utilities Commission (PUCT), whose members serve six-year terms, with the next terms expiring in 2027.

Issuing approval guidance to state agencies — for example, freezing permits not yet granted. Governor-elect Hinojosa has advocated a moratorium on new permits until related laws are passed, focusing only on new, not already-under-construction, projects.

Other measures require legislation: pursuing lasting policy shifts, such as repealing sales tax exemptions; granting local governments veto power, as Hinojosa intends to enable local officials to negotiate with developers, but this needs legal changes; codifying power user protection; mandating union labor for projects. All require legislative approval.

In Ohio, Democratic candidate Amy Acton’s win for governor also introduces major delay risks for data center projects there. Ohio’s largest at-risk project is a 10 GW node by Nvidia and a large US AI lab. Another major ongoing build is Amazon’s 1.5 GW campus in Fayette County.

In May this year, Ohio suspended new data center tax exemption review, while the legislature studies sector growth. Tax exemptions are crucial in data center site selection decisions.

Morgan Stanley expects private infrastructure platforms (PSPs) with major Texas exposure to face pressure. The bank’s preliminary view is that success probabilities for multiple potential Texas projects need to be revised down, especially those constrained by the “batch process.”

Morgan Stanley will closely watch Governor-elect Hinojosa’s statements, particularly whether she may freeze final designation for proposed data center projects in the “batch process.” These include GLXY’s Helios II, CIFR’s Colchis campus, and MARA’s developments.

Morgan Stanley also hopes to further clarify whether in-construction projects will be affected, such as GLXY’s Helios I phases II & III, HUT’s Beacon Point, and CIFR’s various projects. The bank believes these are less vulnerable to policy uncertainty.

By sector, Morgan Stanley expects the Independent Power Producers (IPPs) group overall to see a short-term, sentiment-driven decline, but valuation is still supported by existing asset cash flow, contracts, and forward prices before considering the potential upside from data center business. For power equipment and onsite supply firms, the group could lag, due to risk that industry growth slows—not just Texas exposure. Utilities with heavy Texas exposure stand to be most sensitive to downside risk. Potential impacts come from two angles: slowing data center activity and the 2027 regulatory commission seat turnover, which could mean new, less investor-friendly policies.