Election aftershocks in the global bond market

Michael Leithead, Head of Fixed Income

Bond markets have felt the reverberation of the US election results, with the potential implications varying across geographies. US treasury yields initially jumped higher by around 10 to 15 basis points with a curve steepening bias. The initial move seemed to be all led by inflation expectations as inflation breakevens accounted for the vast majority of the move. Since the initial reaction, the Treasury 10-year yields have climbed further, to around 20 basis points higher since pre-election levels, whilst inflation breakevens have stagnated balancing the impact of real and nominal rate moves. The market had moved substantially ahead of the election as Trump's resurgence became more apparent. This likely reflects a view that Trump's policy mix could lead to greater inflation risk in the medium term and perhaps higher neutral interest rates.

Source: Bloomberg. Data as at 06 November 2024.

In contrast, we've seen German bond yields fall, most notably in the 5-year maturity range, largely as the risk associated with trade policy has become more elevated. Growth risk, in combination with lower oil prices, potentially present a scenario where European rates require a greater structural discount to the US, and potentially more monetary stimulus. In Japan however, a weaker yen presents inflation risk and Japanese Government Bonds have jumped primarily on the expectations that the currency depreciation will force the Bank of Japan to continue to tighten policy more aggressively.

Whilst the reaction in the rates market has been more mixed, from a credit perspective, we've seen a move tighter in line with risk sentiment. The most notable move has been in HY CDS Index where the CDX contract has tightened around 20 basis points. This largely reflects investors taking off hedges after having reduced risk going into the election. With a clearer view on the outlook, investors are likely re-establishing risk.

Emerging market investors had also been reducing risk going into the election and consequently, spreads have compressed. So, although longer duration bonds are lower due to the move in US treasuries, spreads have compressed, particularly in higher beta names. Names like Turkey, South Africa, and even oil related names such as Bahrain have performed strongly. Ukraine bonds are a major winner, as the market prices a higher probability that the new President will weigh in. In contrast, Mexico has lagged, although spreads are tighter post-election results, on concerns of a weaker outlook. Higher US rates and weaker EM FX may present a risk to the assets class further down the line, however, the initial reaction has been positive, despite trade risks.

With the House still to be decided, the markets may have further reaction going forward. A Red sweep may be viewed as being more inflationary and put more pressure on the yield curve as the market re-evaluates the risks to looser Federal Reserve policy. At the current time, Fed Funds Futures have only priced out around half a rate cut over the next year. If Trump addresses what appears to be a key objective, stimulating the economy, then policy expectations may have to be recalibrated.

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