Asset Management: Fixed Income Insights

November 2016 Fixed Income Market Update

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U.S. Election Coverage

The U.S. presidential election will be held next week on November 8th. With the current election pitting two candidates with upside-down likeability ratings and pundits (once again) declaring it the most important election of our lifetimes, we offer a brief election outlook through the lens of fixed income markets:

  • The conventional candidate, Ms. Clinton, is winning by all conventional metrics (polling, newspaper endorsements, campaign funds raised etc.) American election polling is a rather developed science, so the base case assumption, having had a relatively consistent lead through the election cycle, not just currently, is for a Clinton victory.
  • Real Clear Politics averages of polls as of 10/31/2016 shows Ms. Clinton having a nearly 3% lead, though even including all four national candidates, there is over a 5% pool of undecided voters. This level of undecideds and relatively high percentage of voters indicating their preference for a third party (7%), may benefit the anti-status quo (Mr. Trump) as it did in the Brexit surprise. Ms. Clinton, as the nominee of the party currently in power and certainly the more conventional of the candidates, is perceived from this perspective as the status quo.
  • In an already an unconventional election cycle, recent developments from the Trump audio tapes to the surprise that the FBI would review additional Clinton emails discovered as part of an unrelated inquiry, have continued to dramatically alter the election landscape, with the most recent revelations tightening polling results.

From a market perspective, a Clinton victory would likely be a status quo event, while a Trump victory would likely surprise markets both due to baked-in market assumptions (at least currently) and the unconventional nature of his candidacy (this is particularly true for non-U.S. investors investing in U.S. markets.) In our view, the potential market volatility event of a Trump victory would be short lived as markets remember the built in checks-and-balances in the American political system, the enormity of the American economy and the slow moving nature of any changes – particularly for a candidate with uncertain support from their broader party.

Outlook and conclusions

Election conclusions: for these reasons, our base case for either candidate does not significantly alter our economic or Fed outlook, nor our positioning as a whole – though specific industries (for example: energy and healthcare) will experience different impacts. We expect a Clinton win to mean another term for Yellen, while a Trump victory would likely suggest a change at the helm. For both candidates, lower secular growth and an aging population may be more difficult to tackle than they expect, while the American culture of entrepreneurship and innovation are the more likely drivers of an economic breakout than government policy alone.

Minutes from the September 20 – 21 meeting were released in October and highlighted that the Committee expected an interest rate hike “relatively soon,” while the decision not to act in September was a “close call.” The Fed November meeting begins today, November 1, and concludes tomorrow November 2. Given that the current meeting does not include a press conference and is one week before the U.S. presidential election, most speculation is that the realistic timeframe for the next potential rate hike is the Fed’s December 13-14 meeting. At the end of October, Fed Funds Futures implied about a 71% probability of a rate hike by the end of the year.

In our view, the increase in yields in October represents a healthy bounce from all-time lows in July, rather than the beginning of a dramatic shift higher. In this context, it is worth noting that although nearly 40 basis points higher in terms of 10 year yields from the end of July, yields are still approximately 40 basis points below where they began the year. The increase in the U.S. has closely tracked the similar increase in global yields, reinforcing our view of the interconnectivity of global rates markets and the substitution effect we have seen impacting U.S. markets. With the U.S. election picture becoming more muddled rather than clearer as it approaches and market expectations growing around a rate hike in December, the potential for bouts of volatility exists, should either event surprise, though we continue to believe neither is likely to shift the fundamental landscape for fixed income investors.

 

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