Bond fund managers mull long-term US outlook after election

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Fixed income managers are eyeing the US market with caution as the Presidential election draws nigh, the outcome of which could spell major implications for bond yields, interest rates, and the US dollar.

Former Vice President Joe Biden is leading against the incumbent Donald Trump in national polls, and many are predicting a ‘blue wave’ result with the Democratic Party controlling both the Senate and the House of Representatives.

A Democratic sweep is thought likely to give rise to heftier stimulus packages to support an economic recovery in the US, which would also ramp up issuance of Treasury securities to fund relief programmes.

Anthony Carter, fixed income and multi-asset portfolio manager at Sarasin and Partners, says: “The consensus view is that a ‘blue wave’ would lead to a steeper US yield curve – with the Federal Reserve still a few years away from raising interest rates, short-term bond yields will not go up much, while long-term yields will rise on expectations of a major fiscal stimulus package.” 

Jeffrey Sherman, portfolio manager of Nordea’s US Total Return Bond strategy, says that government debt will continue to rise “regardless of the winner”. 

“Both parties are spenders. The notion that Democrats are the spending party and Republicans are ultra-fiscal conservatives was blown out of the water by the Tax Cuts and Jobs Act a couple years ago. There is going to be more spending, irrespective of the leadership. The Trump administration has been free-flowing with money and stimulus is all the talk in town – so I do not see anything changing there if Trump is re-elected.” 

Currently, bonds are in demand as global fund managers are recommending the lowest exposure to equities in portfolios for over a decade, according to a recent poll by Reuters, due to uncertainty around the US election and a second wave of coronavirus. The sell-off in global equities saw falls of 5.7 per cent in the MSCI All World index last week, its steepest decline since March.

The preference for bonds could continue to strengthen due to a poor outlook for equities as a result of a Biden victory, says Adrien Pichoud, chief economist at SYZ Private Banking.

“Recovery permitting, Biden wants to reverse a number of business-oriented policies. He has campaigned for a programme of broad government spending on infrastructure, healthcare, clean energy and education, totalling USD7trn. This would be partly financed by a combination of increased corporate and personal taxes and savings on prescription drug prices. Implemented in full, the programme would significantly raise public deficits and debt. 

“Some of Biden’s proposals, if and when eventually implemented, would therefore be negative for some stock market sectors. The prospect of raising the corporate tax rate from 21 per cent to 28 per cent would trim S&P 500 earnings by as much as a high single digit. This could undermine those sectors that benefitted most from earlier tax cuts, such as financials and industrials.” 

Sherman says that stimulus plans have already increased the US government’s debt load to over 100 per cent of GDP, and that for spending to continue, there “must be a pressure valve”. “Typically, this comes through inflation or currency,” he explains.

Higher interest rates don’t seem unlikely in the long-run, says Sherman. “Looking forward, the challenges for the bond market stem from the yields on offer today. There are some pockets of the market that simply do not offer a lot of value for current levels of risk. 

“If we have a supply of bonds in excess of what the Fed can buy, this could easily put pressure on interest rates – from a supply-demand perspective. Secondly, if you get weakness in the dollar, this could discourage some investment in the US.” 

Quentin Fitzsimmons, portfolio manager of the T. Rowe Price Global Aggregate Bond Fund, adds that the US dollar is also in danger of losing its dominance.

“The US dollar's shine is fading. The dollar's multi-year bull run was supported by two key factors – a preferential interest rate differential and the outperformance of the US economy. On both fronts, circumstances have changed in 2020.”

He says that the impact of lockdowns on the large services sector in the US, combined with the challenge of controlling the virus, has meant that the US economic recovery has so far been slower than in most of its developed market peers. 

“This has put pressure on the dollar, which has weakened against every other G10 currency since April,” says Fitzsimmons, who says that the Federal Reserve’s stimulus programmes could add to the pain. “Fiscal deficits will rise as a result of the Fed's ongoing action and, in the past, this has been negative for the currency.”