Article / 02 November 2016 at 12:00 GMT

Weekly Bond Update: Rate decision 'trumped' by election uncertainty

Fixed Income trader / Saxo Bank
Denmark
  • Polls indicate US presidential election may be closer than first thought
  • Financial markets have been wary of the possibility of a Trump-led administration
  • Consequently bond yields have been uneasy so far this week
  • They are likely to stay this way until the outcome of the election is known

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 Would Donald Trump really want to be the one to burst the economic bubble
if he becomes president? Photo: iStock

By Michael Boye

Tonight, the Federal Open Market Committee, better known as the FOMC, will reconvene for the seventh time this year to discuss interest rate policy. Having already hiked interest rates once this year, the FOMC is widely expected to take advantage of an improving economic outlook and hike its benchmark interest rate again in the near future. 

Currently, though, the market is looking with greater conviction at next month's December 14 meeting, with current market future prices implying a 71% chance for a move just before Christmas, while there's only a 16% chance – the equivalent of throwing a six – riding on tonight's statement will include another rate hike. 

Under normal circumstances, this would be plenty to keep the entire investing community in suspense in those hair-raising minutes when the statement is released. But tonight's event has been overshadowed – or "trumped" if you like – by another huge potential market mover.

And while any of the decision makers tonight might be reluctant to admit the coincidence, the upcoming US presidential election – which is now less than a week away – will probably have its share of the impact on the expected decision to stay passive. 

This week, fresh indication polls indicate the race to become the next US president could be a lot more thrilling than what it looked like just a few weeks ago, as the re-opening of the email investigation against Hillary Clinton seemingly has inspired a comeback for the Donald Trump campaign.

You will hear many arguments over which side of the political landscape has the better prospects for financial markets traditionally, but above anything else, investors will always be more concerned about uncertainty and political stability. 

For this reason, in this election, the financial markets have been wary of the possibility of a Trump-led administration, given his rather outspoken, ambiguous character and controversial policies. These include protective anti-trade initiatives to prevent US manufacturers from exporting jobs overseas, and criticism of the "bubble economy" induced by the – according to Trump – politically biased Federal Reserve.

Donald Trump takes the lead in the latest ABC/Washington Post poll:
CLINTONTRUMP
Source: ABC News, Washington Post

Consequently, financial markets – including bond yields – have been uneasy so far this week, and are likely to stay this way until the outcome of the election is known, especially if opinion polls confirm the gap between the two to be narrowing further.

The big question that everyone is asking right now is what would happen if Trump actually wins, which in turn could be easily answered with: "No one knows" – and in itself this underlines the uncertainty at the core of the markets' nervousness right now. Turmoil and risk-off, however, would be likely in the short-term, resulting in falling equity prices and rising bond prices. Emerging markets would intuitively be more vulnerable, especially Mexico (immigration) and China (trade policies), which have been at the centre of attack in Trump's rhetoric agenda.

On the slightly longer term though, the image gets significantly more blurred – especially for the interest rates market. Donald Trump has had no reservations in calling out Janet Yellen for being the right-hand woman to the Barack Obama administration (an accusation which, to be fair, has been put forward against several government officials), blaming her for keeping interest rates too low for too long in order to prevent the bubble economy from falling apart. 

While the concerns over whether the economy has been artificially supported by low interest rates for too long are legitimate, and shared by a more than a few – ourselves included - there is no reason to think that Janet Yellen is taking orders directly from the White House. In fact, by maintaining a rate hike agenda in spite of the stressful impact it has had on financial markets on several occasions, the current leadership of the Federal Reserve has been surprisingly adamant about normalising interest rates and ending the days of zero interest rate policy.

The 10-year US government yield has been
on the rise since summer as rate-hike momentum has strengthened
US10Y
 














Source: Bloomberg

But neither Janet Yellen, nor Donald Trump – should he win the Oval Office – has any interest in raising interest rates too soon and too quickly. The same could be said for raging a trade war with China, which could quickly evaporate any confidence in the still very fragile economic recovery in the US. As a pragmatic businessman no one is more aware of this than Trump himself. 

For historic reference, we might not need to look further than the surprise Brexit decision earlier this year in the United Kingdom. Despite various doomsday prophesies and a major selloff initially, the British economy has survived and is doing just fine. Q3 GDP growth even surprised to the upside – and its stock market is now trading significantly higher. Could we be in for a repeat this time? We don't know, and that's the problem.

– Edited by Gayle Bryant

Michael Boye is a fixed income trader at Saxo Bank

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