The chart above shows an ETF that holds US treasury notes that mature in 20 or more years. US Treasury notes are US sovereign bonds issued by the United States government. If interest rates rise, the prices of bonds fall, as does the price of this ETF. In fact, holders of this ETF have last more than 35% over the last three years.
While the US central bank, the Federal Reserve or “Fed”, sets the rate for short-term borrowing, longer treasury yields are set more by market forces. Interesting to note that the recent high point for long-term bonds (or the recent low in yields) in mid-September occurred on the very day that the Fed started cutting rates for the first time since the pandemic, chopping 0.50% off the short-term borrowing rate. Why? Could this be the market telling us that it is concerned that the Fed is worried more about ensuring that the government can afford to service its debt rather than setting rates appropriately to the levels of inflation and economic growth in the economy? Or was the fall in bonds, or rise in yields, mostly related to the surprising resilience of the US economy? Or how much of the weakness in the bond market had to do with the sharply rising odds from early October of Trump winning the presidency and bringing tax cuts that worsen already massive US deficits? It’s very hard to know the answer – but getting to the other side of the election will make us much wiser on why the US bond market has been so weak and whether it will remain a source of concern for all markets.
The US treasury market and the US election
A couple of weeks back, when the odds of a Trump victory were rising strongly in betting markets, many observers noted that the markets appeared to be positioning for a Trump presidency and that the sharp rise in US treasury yields was one of the signs of that, as a Trump 2.0 presidency would mean much larger deficits after a new round of Trump tax cuts. Trump’s odds of winning have dropped significantly over the last week, but US Treasury yields continued to surge into the end of last week, even if the situation cooled early Monday. This makes it less clear that the rise in yields has mostly to do with the election and perhaps as much to do with Fed policy and the backdrop of enormous and rising US debt levels.
Regardless, interest rates are critical to follow for all investors when they are flashing red as they are now. Getting to the other side of the election tells us (and the new president) whether the bond market will remain weak or breathe a sigh of relief – for example on a “gridlock” scenario, in which the president’s party does not have control of both houses of Congress.
The US treasury market is the centre of gravity for global markets, and the world can’t afford a weak treasury market, which not only weakens bond markets globally, but can drive uncertainty and volatility in equity markets as well because it impacts stock valuations. And there are no easy solutions to bringing order to a chaotic bond market, either. Big cuts in government spending to shrink the deficit would tank the economy, while Fed intervention to bring order could blast the US dollar lower and worsen inflation. The bond market will be priority number one for markets and for the incoming president if it doesn’t shape up post-election.
Brace for impact
That’s it for this week. If the election is tilting more aggressively in favour of either candidate than the polls suggest, markets may begin reacting within a couple of hours of the polls closing in the first big states in the east, starting at mid-night Tuesday night, GMT time. If things are nail-biting close, we may not know the full picture until closer to the weekend.
This article series will continue for two more weeks after the election. See you next week!
About the author: John is Saxo’s Chief Macro Strategist, with over twenty-five years’ experience in the financial markets, chiefly as Saxo’s former Head of FX Strategy. He is also an American, having grown up in Houston, TX and has a long-standing passion for following the course of US elections and their place in history since being allowed to stay up late as a young kid to watch the 1980 election results roll in and Ronald Reagan winning the presidency over Jimmy Carter.
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