Bond Market’s Big Short Teeters With Stimulus Bets Taking a Hit

The U.S. election was supposed to pave the way for a sell-off in Treasuries. Yet the opposite has happened in a race that remains too close to call.

Treasuries jumped along with most other major government bond, as ballots tallied so far dashed expectations for a Democratic sweep and upended bets for major debt-financed stimulus spending. A victory claim by President Donald Trump only added momentum to the rally. With results in key states such as Pennsylvania, Michigan and Georgia likely to take time, uncertainty is poised to remain high.

Yields on the 10-year Treasury bond fell nearly 14 basis points, the largest daily drop in seven months, to 0.76% as Trump’s claims fueled concerns about a contested election. Those in Europe followed suit, with German 10-year yields sliding as much as five basis points to -0.67%.

“The short Treasuries trade is really coming back to bite,” said George Boubouras, head of research at hedge fund K2 Asset Management in Melbourne. “Investors are clearly pricing in a ‘no blue wave’ scenario,” a higher possibility of a Trump victory and a more fiscally conservative stance, he said.

Bond Market’s Big Short Teeters With Stimulus Bets Taking a Hit

The turnaround is putting at risk the record short positions in bond futures that leveraged investors had piled into in response to polls showing a likely win for Biden, and possible majority for Democrats in both houses of Congress. Volumes in Treasury futures -- typically subdued during Asia hours -- surged to around eight times normal levels, according to Bloomberg calculations.

Rates Traders Add to Big Short Bet in Advance of Crucial Week

Trump’s robust performance in key battleground states such as Florida and Ohio have driven the 10-year yield back from its highest level since mid-year. The benchmark sank back below its 200-day moving average as the vote counting progressed.

Yields on the 30-year bond fell as much as 17 basis points to 1.51% after Trump said he would ask the Supreme Court to intervene, even as several battleground states continue to count votes. S&P 500 futures briefly dropped on his claims, before reversing the decline.

“The close fight has raised the specter of contested elections and thrown doubts over fiscal stimulus,” said Eugene Leow, a fixed-income strategist in Singapore at DBS Group Holdings Ltd. “Depending on how messy things get, 10-year yields can drop to the 0.7%-0.75% area in the short-term.”

See here for more on Wall Street’s issuance forecasts.

Big Reversal

At one point, both bonds and stocks were surging in tandem, compounding recent concerns about a breakdown in the inverse correlation between the two asset classes, which could jeopardize the traditional 60/40 asset allocation strategy.

With some key states still hanging in the balance, including Pennsylvania and Michigan, markets may be at risk of still more reversals in the days and weeks to come. Biden was seen taking the lead in Wisconsin, albeit narrowly, boosting his chances.

The ICE BofA MOVE Index, a gauge of U.S. bond volatility, climbed to the highest level since April.

Moreover, the election is just the start of a jam-packed week for bond traders. The Treasury’s announcement Wednesday of its quarterly issuance plans could produce more sharp yield swings, and the Federal Reserve releases a policy decision Thursday. It’s all happening against the backdrop of rising global coronavirus cases and renewed lockdowns, which continues to muddy the economic outlook.

“The bond market was efficiently priced for a blue sweep and potential for higher deficit spending,” said Subadra Rajappa, head of U.S. rates strategy at Societe Generale SA. Now, “it is looking less likely that we will have the final results soon. So you are seeing a flight to safety as bond investors brace for uncertainty.”

Still, as 2016 showed, market sentiment can shift dramatically in a single day. Back then, the unexpectedly upbeat reaction to Trump’s victory left many on Wall Street red-faced. Initially, Treasuries soared on election day, while U.S. stock futures plunged and the dollar tumbled.

Less than 24 hours later, markets had a dramatic turnaround, with investors starting to price in the prospects of tax cuts and increased spending. The Dow Jones Industrial Average produced one of the biggest single-day reversals in history, the greenback rallied against most major peers, and bond yields climbed.

For now though, the prospect of a divided senate and Presidency is looming large and is likely to be the worst-case outcome for markets, according to Simon Harvey, a foreign-exchange analyst at Monex Europe. That’s because any deadlock is likely to harm prospects for fiscal expansion and the growth outlook.

“A partisan deadlock can be as bad, if not worse, for markets than this prolonged period of uncertainty,” he said. It “will only lead to markets downgrading their global growth outlook further.”

©2020 Bloomberg L.P.

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