Bond Market’s Reflation Bets Face Risk of a Divided Government

(Bloomberg) — Even the bond bears are starting to wave warning flags about the degree

(Bloomberg) — Even the bond bears are starting to wave warning flags about the degree to which markets are leaning toward a clear win by Democrat Joe Biden in next month’s presidential election, with his party also taking control of Congress.


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Not long ago, investors were bracing for volatility in the weeks after the Nov. 3 vote, given the risk of a contested outcome. But President Donald Trump has been trailing by double digits in some national polls, spurring speculation a Democratic sweep will pave the way for supersized fiscal spending.

That backdrop gave fresh impetus last week to bets on a reflating economy, pushing the yield curve to its steepest since June. And it also may be setting the market up for potential pain if the scenario doesn’t pan out.

“If current polling trends hold, the odds of ending up with a contested election should drop, and divided government (with Republicans retaining control of the Senate) would supplant the contested election scenario as the more likely ‘yields lower’ outcome,” Praveen Korapaty, chief interest-rate strategist at Goldman Sachs Group Inc., wrote in a note.

chart: A failed Democratic wave risks pushing long-term yields lower

© Bloomberg
A failed Democratic wave risks pushing long-term yields lower

“We continue to like being short in the belly of the U.S. curve in various forms” including curve steepeners, “though we’d watch for the evolving risk/reward trade-off if a Blue wave gets increasingly priced,” he wrote.

Korapaty forecasts the 10-year Treasury yield, now about 0.76%, will end the year at 1.05% and finish 2021 at 1.45%.

Underscoring the mounting bearish sentiment, some options traders on Monday were even hedging a possible move higher in 10-year yields sometime before Nov. 11 to about 1.50%. And speculators as of last week ramped up net short positions in bond futures to fresh records.

Read about research on stock picks expected to benefit from a Democratic sweep.

“Three weeks until the election is practically an eternity in 2020 time, so additional narrative shifts are definitely possible,” Solita Marcelli, Americas chief investment officer at UBS Financial Services, wrote in a note with Jason Draho, head of Americas asset allocation. “Too much optimism being priced in too soon could also lead to a potentially perverse situation in which investors are disappointed if a Blue Wave doesn’t happen.”

Read More: Investors Turn Skeptical of U.S. Democrat ‘Blue Wave’ Victory

(Updates pricing, adds tout.)

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