Key Takeaways
U.S. economic and military influence in a multipolar world remains a primary focus, which may provide a tailwind for defense stocks.
New tax cuts are projected to bolster consumer spending throughout 2026, potentially benefiting companies in the consumer staples sector.
Political pressure, significant U.S. deficits, and spikes in oil prices present challenges for an embattled Federal Reserve, potentially driving bond market volatility, higher long-term interest rates, and a weaker dollar.
Although markets experienced a brief rally following the Supreme Court’s decision to block the White House’s emergency-based tariffs, the administration will likely pursue alternative methods to implement them.
As the U.S. midterm elections draw near, 2026 is poised to bring significant shifts in government policy that could impact both the broader economy and financial markets. Below are the primary policy and regulatory developments to monitor, along with their potential implications for your investment portfolio.
1
Affordability Dominates Ahead of Midterms
Republican control of Congress appears vulnerable heading into the 2026 midterms, with affordability emerging as a central campaign theme. In response, the administration is introducing targeted initiatives designed to lower mortgage rates, protect housing for families, decrease prescription drug costs, and cap credit card interest rates to alle
Investor implications: While these measures could lower costs for households, they may also introduce market risks. Certain pharmaceutical companies and financial institutions, for instance, are likely to face increased headwinds.
2
Geopolitical Risk and Strategic Resource Access In Focus
The conflict in Iran serves as the latest major example of the U.S. actively asserting its economic and military influence amid heightened geopolitical risk and competition for strategic resources, including land deals, minerals, and energy. Oil prices have climbed since military strikes in the Middle East began in early March, increasing risks to energy shipments through the Strait of Hormuz—a vital chokepoint that typically handles roughly 20% of global oil flows. Higher energy costs could squeeze consumers and intensify affordability concerns.
The U.S. is also pursuing various policy measures to decrease its dependence on China for rare earth elements, a strategic necessity linked directly to technological autonomy and national defense. The focus of the U.S. will likely continue to shift across global regions—from the Middle East and Latin America to Russia-Ukraine, the Indo-Pacific, and evolving U.S.-EU relations.
Investor implications: We expect geopolitical tensions to support robust U.S. defense spending, likely boosting defense stock performance. Defense “prime contractors” should continue to benefit, along with companies specializing in drones, missile defense systems and satellite technologies.
We expect geopolitical tensions to support robust U.S. defense spending, likely boosting defense stock performance.
3
Tax Cuts Offer Boost to Consumers and Businesses
The economic advantages of tax cuts and other business-friendly provisions within the One Big Beautiful Bill Act (OBBBA) are <a s independence. The administration’s push could result in not only lower short-term rates but also a potential restructuring of the Fed’s leadership.
This is occurring while high U.S. government debt and deficits are straining the central bank’s capacity to implement monetary policy effectively. Furthermore, if the new Fed chair appointed to succeed Jerome Powell in May favors rate cuts, inflation, further complicating the Fed’s trajectory.
If there is major organizational change at the Fed, investors should brace for interim bond market volatility.
Challenges at the Fed stoke uncertainty in markets. Given all this, we expect a weaker U.S. dollar, a steepening yield curve and higher “term premiums”—the extra yield long-term bond investors demand to compensate for future policy-related uncertainty.
5
Trade Uncertainty Could Continue Moving Markets
Two primary trade issues remain on the policy agenda for 2026:
First, trade policy uncertainty persists throughout 2026. Even though the Supreme Court invalidated President Trump’s use of the International Emergency Economic Powers Act (IEEPA) to enact tariffs, the administration has significant recourse to impose levies by invoking alternative sections of U.S. trade law and has signaled a “plan B” that includes product-specific and time-limited tariffs. Adding to the complexity, the high court did not explicitly address the possibility of tariff refunds, which may require adjudication in lower courts.
Meanwhile, the renegotiation of the United States-Mexico-Canada Agreement (USMCA) expected this summer may result in tighter trade restrictions on China and closer North American alignment in an increasingly deglobalizing world.
Stocks initially rallied on the Supreme Court ruling. However, the administration’s response, uncertainty around possible refunds and their potential to expand the U.S. deficit, could introduce fresh volatility into equity markets. Greater deficit expansion and debt issuance could also put upward pressure on long-term bond yields.
Headline-driven risk around the USMCA between now and the renegotiation is likely. However, a reaffirmation of trade relations with the U.S.’s two largest trading partners would provide some clarity for investors and potentially boost investments tied to the “near-shoring” theme, in which companies relocating production or supply chains closer to home markets stand to benefit.
6
CLARITY for Digital Assets
The GENIUS Act, signed into law in July 2025, establishes a regulatory framework for stablecoins—cryptocurrencies pegged to high-quality collateral or fiat currencies, typically the U.S. dollar and U.S. Treasuries. Next on the congressional agenda is the CLARITY Act, which aims to regulate stablecoins, define regulatory roles, and clarify the treatment of crypto assets.
Investor implications: Because stablecoin issuers are required to hold high-quality liquid assets to back their tokens, the growth of digital assets and stablecoins could increase demand for “safe haven” U.S. Treasuries and the dollar, potentially lowering government borrowing costs while strengthening the greenback’s role in global finance.
7
Improved Health Care Outlook
The health care sector is positioned for a recovery as policy uncertainties begin to fade. While the recent expiration of Affordable Care Act (ACA) subsidies has led to higher insurance premiums for millions of Americans, the reinstatement of these subsidies remains a possibility ahead of the midterm elections, which could benefit insurers participating on ACA exchanges.
Greater policy clarity combined with an improving macroeconomic backdrop should benefit biotech and insurance companies, with lower interest rates and a more relaxed regulatory environment likely supporting mergers and acquisitions.
Corporate tax cuts under OBBBA could also benefit medtech and biotech firms by enabling them to claim R&D tax benefits, among others.
Health care has historically been the top-performing sector during midterm election years. Given the recent tailwinds, these stocks may still have room to run in 2026.
Your Morgan Stanley Financial Advisor can help you stay informed about policy and geopolitical developments and their potential portfolio implications. To learn more, ask your Financial Advisor for a copy of the report US Policy Pulse: 10 Policy Actions to Watch in 2026 from Morgan Stanley’s Global Investment Office.
Disclosures
Important note regarding economic sanctions. This report may reference jurisdiction(s) or person(s) that are the subject of sanctions administered or enforced by the U.S. Department of the Treasury’s Office of Foreign Assets Control (“OFAC”), the United Kingdom, the European Union and/or by other countries and multi-national bodies. Any references in this report to jurisdictions, persons (individuals or entities), debt or equity instruments, or projects that may be covered by such sanctions are strictly incidental to general coverage of the relevant economic sector as germane to its overall financial outlook, and should not be read as recommending or advising as to any investment activities in relation to such jurisdictions, persons, instruments, or projects. Users of this report are solely responsible for ensuring that their investment activities are carried out in compliance with applicable sanctions.
Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.
Investing in foreign markets entails greater risks than those normally associated with domestic markets, such as political, currency, economic and market risks. Investing in currency involves additional special risks such as credit, interest rate fluctuations, derivative investment risk, and domestic and foreign inflation rates, which can be volatile and may be less liquid than other securities and more sensitive to the effect of varied economic conditions. In addition, international investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These risks include political and economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets and frontier markets, since these countries may have relatively unstable governments and less established markets and economies.
Bonds are subject to interest rate risk. When interest rates rise, bond prices fall; generally the longer a bond’s maturity, the more sensitive it is to this risk. Bonds may also be subject to call risk, which is the risk that the issuer will redeem the debt at its option, fully or partially, before the scheduled maturity date. The market value of debt instruments may fluctuate, and proceeds from sales prior to maturity may be more or less than the amount originally invested or the maturity value due to changes in market conditions or changes in the credit quality of the issuer.
Bonds are subject to the credit risk of the issuer. This is the risk that the issuer might be unable to make interest and/or principal payments on a timely basis. Bonds are also subject to reinvestment risk, which is the risk that principal and/or interest payments from a given investment may be reinvested at a lower interest rate.
High yield bonds (bonds rated below investment grade) may have speculative characteristics and present significant risks beyond those of other securities, including greater credit risk, price volatility, and limited liquidity in the secondary market. High yield bonds should comprise only a limited portion of a balanced portfolio.
Growth investing does not guarantee a profit or eliminate risk. The stocks of these companies can have relatively high valuations. Because of these high valuations, an investment in a growth stock can be more risky than an investment in a company with more modest growth expectations.
Value investing does not guarantee a profit or eliminate risk. Not all companies whose stocks are considered to be value stocks are able to turn their business around or successfully employ corrective strategies which would result in stock prices that do not rise as initially expected.
Treasury Inflation Protection Securities’ (TIPS) coupon payments and underlying principal are automatically increased to compensate for inflation by tracking the consumer price index (CPI). While the real rate of return is guaranteed, TIPS tend to offer a low return. Because the return of TIPS is linked to inflation, TIPS may significantly underperform versus conventional U.S. Treasuries in times of low inflation.
Yields are subject to change with economic conditions. Yield is only one factor that should be considered when making an investment decision.
Environmental, Social and Governance (“ESG”) investments in a portfolio may experience performance that is lower or higher than a portfolio not employing such practices. Portfolios with ESG restrictions and strategies as well as ESG investments may not be able to take advantage of the same opportunities or market trends as portfolios where ESG criteria is not applied. There are inconsistent ESG definitions and criteria within the industry, as well as multiple ESG ratings providers that provide ESG ratings of the same subject companies and/or securities that vary among the providers. Certain issuers of investments may have differing and inconsistent views concerning ESG criteria where the ESG claims made in offering documents or other literature may overstate ESG impact. ESG designations are as of the date of this material, and no assurance is provided that the underlying assets have maintained or will maintain and such designation or any stated ESG compliance. As a result, it is difficult to compare ESG investment products or to evaluate an ESG investment product in comparison to one that does not focus on ESG. Investors should also independently consider whether the ESG investment product meets their own ESG objectives or criteria. There is no assurance that an ESG investing strategy or techniques employed will be successful. Past performance is not a guarantee or a dependable measure of future results.
Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies. Technology stocks may be especially volatile. Risks applicable to companies in the energy and natural resources sectors include commodity pricing risk, supply and demand risk, depletion risk and exploration risk. Health care sector stocks are subject to government regulation, as well as government approval of products and services, which can significantly impact price and availability, and which can also be significantly affected by rapid obsolescence and patent expirations.
REITs investing risks are similar to those associated with direct investments in real estate: property value fluctuations, lack of liquidity, limited diversification and sensitivity to economic factors such as interest rate changes and market recessions.
Virtual Currency Products (Cryptocurrencies)
Buying, selling, and transacting in Bitcoin, Ethereum or other digital assets (“Digital Assets”), and related funds and products, is highly speculative and may result in a loss of the entire investment. Risks and considerations include but are not limited to:
Digital Assets have only been in existence for a short period of time and historical trading prices for Digital Assets have been highly volatile. The price of Digital Assets could decline rapidly, and investors could lose their entire investment.
Although any Digital Asset product and its service providers have in place significant safeguards against loss, theft, destruction and inaccessibility, there is nonetheless a risk that some or all of a product’s Digital Asset could be permanently lost, stolen, destroyed or inaccessible by virtue of, among other things, the loss or theft of the “private keys” necessary to access a product’s Digital Asset.
Digital Assets may not have an established track record of credibility and trust. Further, any performance data relating to Digital Asset products may not be verifiable as pricing models are not uniform.
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