HedgeTalk: The Biggest Risk to Interest Rates - A Smooth Presidential Election
By: John Trefethen, Director & Co-Founder
For months the bond market has priced the likelihood of a messy political battle over the results of the US presidential election into bond prices. This has been one of several factors that have kept US Treasury rates at or near historical lows. Below is the current Treasury yield curve as of Oct 13, 2020 showing the historical low rates including a 10-year Treasury yield of just 0.74%.
One scenario that could shake up the bond market and cause yields to increase would be a presidential election that produces a clear and undisputed winner. This is one of the more under-appreciated risks of the November 3rd election with the potential to push the 10-year back over 1.00% in the weeks that follow the election, a level we haven’t seen since March 4, 2020 when it was 1.02%. To give further context on just how far rates have fallen, at the beginning of 2020 the 10-year Treasury yield sat at 1.88% - it has steadily dropped since that time.
The consensus bet has been that the election outcome will be marred by lawsuits, claims of voter fraud, and overall angst. This has kept many investors in Treasuries as a safe haven for post-election turmoil. As long as this demand continues, rates will remain low.
But what if the winner of the election is clear and undisputed? If this happens, a significant element of political risk will be eliminated which will help bring some certainty back to the markets. In this scenario it can be expected that many investors will liquidate their safe haven positions in Treasuries and move into equity positions in search of higher returns. The exodus of investors from Treasuries will cause the value of Treasury securities to drop which will push yields up.
Regardless of a clean or messy post-election, eventually a winner will be identified. This along with other factors such as a COVID-19 vaccine is sure to bring calm to the markets and usher in higher interest rates. Whether your exposure to interest rates is on the asset or liability side of your balance sheet, higher rates is a risk that risk managers need to be anticipating.
To learn more on how to manage exposure to interest rates contact one of our experts!