Bond Traders Ditch Bets on Heavy Stimulus in Tight U.S. Election

(Bloomberg) -- Bond traders have shredded bets for aggressive fiscal stimulus, sending Treasury yields sharply lower as counting for key states progresses in a tight U.S. election, just ahead of a Federal Reserve policy decision.

The likelihood of a divided government has delivered a blow to calls for a surge in yields on the expectation of a large relief package. Even the U.S.’s announcement on Wednesday of record quarterly debt sales couldn’t damp the biggest one-day rally in months, with a slight tilt toward shorter-dated issuance helping to flatten the yield curve.

“You are left with a couple of troubling issues that are out there. There is going to be no fiscal stimulus, that should slow the economy,” as well as the ongoing virus resurgence in the U.S., said Jim Bianco, president and founder of Bianco Research, said on Bloomberg TV.

That’s bullish for bond markets, he said, though the decline in yields is likely to be modest, as the March low in the 10-year was “the end of the bull market for bonds.”

The abrupt shift in the outlook for government aid raises the stakes for the Fed’s announcement Thursday. Chair Jerome Powell is unlikely to make significant policy shifts, but investors are looking for cues on the prospect of more stimulus, with trades based on stronger growth and inflation at risk. The Fed has pushed for lawmakers to step up fiscal support, with its policy options looking sparse in a zero-interest rate world.

“The Fed may get involved, but that will ultimately be a reflection of how presidential policies pan out. There’s just a lot unknown now,” said Glen Capelo, head of rates trading at Mischler Financial.

Treasuries jumped along with most other major government bonds Wednesday as expectations for a Democratic sweep fell flat. Key states Michigan and Wisconsin have been called for Democrat Joe Biden, putting him on the brink of taking the White House hours after the president’s team opened legal fights to stop vote counting in at least two states.

A premature victory claim by President Donald Trump Wednesday only added momentum to the rally in havens, raising concerns about a contested result.

The twists and turns of the race saw longer-dated bonds swing in the largest daily trading range since March. Yields on the 10-year Treasury note fell as much as 14 basis points to steady around 0.74%, while 30-year yields fell as much as 18 basis points after Trump said he would ask the Supreme Court to intervene. That flattened the curve 15 basis points from from its steepest incline since 2016, to 118 basis points.

The drop in long-end yields drew support from the release of the Treasury Department’s latest auction plans. It announced that the government will lean less heavily on longer-dated issuance as it ramps up overall sale sizes to fund the budget deficit.

While sale sizes for 10- and 30-year debt will increase, the pace will be slower than last quarter. The three-year issue rose by the same amount as last time.

The monthly jobs report is also due on Friday and that may put the spotlight once again on the economic fallout of the pandemic and lockdowns.

If the economy softens, virus cases rise and Washington fails to enact stimulus, the Fed will be in a position to do more, according to Nathan Sheets, chief economist at PGIM Inc.

“In that scenario, the Fed would likely respond by doing more as opposed to withholding stimulus, trying to leverage Washington,” he said. “I don’t think Jay Powell’s going to get into that kind of game.”

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