Democrats notched early wins in the US Senate, fuelling expectations that they could wrest control of the chamber from US President Donald Trump's Republicans and raising the possibility of a Democratic sweep in the midterm elections. However, the final outcome remained uncertain.

The emerging results triggered an immediate reaction across financial markets, with US stock futures falling sharply, Treasury yields declining and the dollar weakening as investors assessed the implications of a potential shift in political power in Washington, Reuters reported.

Read more: US stocks today: Nasdaq rebounds as chipmakers rally, Apple slides ahead of US midterm results

The prospect of a divided government has raised questions about the scope for further fiscal stimulus and the direction of the Trump administration's policy agenda.

Michael Arone, chief investment strategist at State Street Global Advisors, said the key risk for financial markets was not a Democratic sweep itself, but the possibility of investors overreacting to the election outcome.

Mark Malek, chief investment officer at Siebert Financial, expected some volatility overnight and into the next trading session but did not anticipate a major market disruption. He said the election outcome appeared to have been largely priced into asset markets, adding that an unexpectedly strong Republican performance could have triggered a bigger reaction. The comments were reported by Reuters.

Read more: Global Market Today: Asian shares retreat as US futures slide on mid-term election bets

Divided government could limit fiscal expansion

A potential Democratic takeover of Congress could constrain Trump's legislative agenda during the remaining two years of his presidency, although his executive powers would remain intact.

Tai Hui, chief market strategist for Asia-Pacific at J.P. Morgan Asset Management, said a divided government could limit the scope for changes to existing legislation, including healthcare spending provisions and restrictions on renewable energy. It could also result in tighter control over fiscal deficits, while the administration would retain considerable influence over trade, tariffs, foreign policy and existing regulations, Reuters reported.

The debt ceiling, which is expected to become an issue next year, could emerge as another potential source of friction between the White House and Congress.

However, Hui cautioned against attributing the entire market reaction to the election. He suggested that concerns surrounding the artificial intelligence trade, which have gained momentum over the past three to four weeks, could be a bigger factor behind the recent weakness in equities.

Nasdaq futures face pressure amid AI concerns

Nasdaq futures came under particular pressure, reflecting concerns that a change in political control could lead to greater regulatory scrutiny of artificial intelligence companies and Big Tech.

Charu Chanana, chief investment strategist at Saxo in Singapore, said markets appeared to be pricing in a stronger-than-expected Democratic performance, potentially lowering expectations of further fiscal stimulus. This was weighing on equities and the dollar.

She added that concerns over regulatory scrutiny of AI and large technology companies were adding to pressure on Nasdaq futures, as investors were already questioning elevated valuations and the scale of AI spending.

However, the decline in Treasury yields could eventually offer some support to equities, suggesting that the initial market selloff may not necessarily be sustained.

Political outcome may not change Trump's governing style

Jesper Koll, expert director at Monex Group, said a potential Democratic takeover of Congress might have a limited impact on policymaking, given Trump's reliance on executive orders, Reuters reported.

He expected political tensions to intensify, potentially leading to investigations and other congressional confrontations, but did not anticipate a fundamental change in the president's governing approach.

Koll also argued that the weakening momentum in AI-related stocks was largely independent of the election outcome. Concerns surrounding AI valuations, investment spending and the broader technology sector extended beyond political considerations.

On the currency front, he suggested that the election outcome could ultimately support the dollar if investors increasingly focused on the prospect of greater Federal Reserve independence.

With the final election results still awaited, investors are likely to track both the balance of power in Congress and developments in the AI trade to assess the next direction of global financial markets.

(Disclaimer: This article is based on inputs from agencies. These do not represent the views of The Economic Times)