Amid all of the investor focus on a potential messy political battle over the results of the U.S. presidential election, there is one scenario that could shake up the bond market the most: A clear and undisputed winner.
This is likely one of the most-underappreciated risks of the Nov. 3 vote, with the potential to push the 10-year Treasury yield back to 1% in the weeks that follow, a level it hasn’t touched since the first quarter. While it may not be the base case for many prominent investors, some are positioning for it just in case.
Nick Maroutsos of Janus Henderson Investors is building a “war chest of cash,” among other things, in part to react to opportunities from any volatility the election produces through year-end. Goldman Sachs Group Inc. strategists say a scenario in which Democrats take the White House and both chambers of Congress -- what’s known as a “blue sweep” -- “would imply the most upside to yields.”
“A strong, broad, blue victory, one that empowers the more progressive caucus in the House, is the only scenario I see in which long-end rates would spike by a lot after the election,” said Gregory Staples, head of fixed income at DWS, which oversees about $800 billion globally. “A mandate to significantly stimulate fiscally would possibly scare bond vigilantes, steepening the yield curve. I don’t view this as likely. But we are confronted with multiple scenarios, of which this is one.”
The risk that yields pop higher is deemed so unlikely that traders of eurodollar options are more focused on a possible year-end funding squeeze than the U.S. election. Strategies that typically might be used to hedge event risk are finding little demand and volatility remains near historically low levels. Even cheap, speculative bets on more turbulence aren’t finding a bid, despite the possible payoffs, according to traders.
Nonetheless, the notion of an unassailable victory by Joe Biden is beginning to take hold: A sweep by the Democratic Party that causes a bear steepening of the Treasury yield curve, in which long-end rates rise faster than short end, is quickly becoming a consensus trade.
Maroutsos, who is head of global bonds at Janus, actually sees a greater likelihood of an election outcome marred by lawsuits, claims of voter fraud, and overall angst that produces short-term swings in both directions for 10- and 30-year Treasury rates. Still, he’s positioning now for a potentially bigger, though contained, upward spike in long-end rates if his non-base-case scenario of a clean election result comes to fruition.
Long Rates ‘Vulnerable’
“With rates approaching all-time lows and the Federal Reserve on hold indefinitely, there is risk that the back end could be vulnerable due to a positive-type shock,” he said, without predicting whether Biden will win or Donald Trump will be re-elected.
He figures such a development could push the 10-year yield to as high as 1% by year-end or early 2021, from a current level of 0.65%, and the 30-year rate to just under 2% from 1.42% now. The 10- and 30-year rates haven’t been at those levels since March and February, respectively.
Maroutsos isn’t alone in his views. Goldman strategists Praveen Korapaty and Avisha Thakkar also see the potential for the 10-year note’s yield to rise by 30 to 40 basis points by early December on expectations of increased government spending, if Democrats take the White House along with control of the House and Senate.