If President Donald Trump gets his wish and Republicans hold Congress, he may also get something he doesn’t like — even higher interest rates.
The view in the bond market has been that a GOP Congress would be more likely to move forward with making the individual tax cuts permanent and boosting stimulus spending — two things that could make the already expanding budget deficit even larger. That means more debt issuance by the Treasury, and that’s a negative for bonds. Yields would then rise as bond prices fall.
“A Republican-led Congress could introduce more tax cuts, leading to higher budget deficits, more issuance of U.S. Treasuries—and potentially higher bond yields. Republicans may seek to extend the life of individual tax cuts and try again to repeal the Affordable Care Act,” wrote BlackRock strategists.
A GOP surprise would also be better for growth, and that could be a catalyst for higher rates, according to John Briggs, head of strategy at NatWest Markets.
“If the Republicans hold, stocks are relieved and we’ll see a bit of a fixed income market reaction. It could be more muted than the equity market. Even if the Democrats take over, the Fed is still going to go two or three times,” said Briggs. A GOP win is “positive for risk, so rates go up a bit. Business confidence keeps growing. You don’t’ have deregulation roll off.”
But Briggs does not agree that the GOP would drive the deficit higher. “I don’t necessarily see that. If they hold the their House majority, it’s going to be quite narrow and the deficit is quite large as it is. If they go through reconciliation, they still have to go through the Senate but there’s just too many roadblocks.”
If Democrats pull off a midterm surprise and take both houses of Congress, that would be a negative for stocks and could create a temporary flight to quality in bonds.
But Michael Schumacher, director rate strategy at Wells Fargo said a sweep either way means higher rates because of more potential for spending. He sees a GOP sweep as more likely and a jump in spending a probable outcome.
“Why would they control spending? They haven’t done it so far. More spending seems likely if you get a sweep either way. The U.S. deficit— it’s a fact it’s five percent of GDP, the biggest in quite some time. It was 10 percent in the peak of the financial crisis but as far as a non-crisis year, it really stands out,” said Schumacher. “If you get the sort of expected outcome which is Democratic House, Republican Senate, I think it’s not terribly interesting. Maybe there’s a mild rally in bonds, but not much.”
Strategists said a Democratic sweep could send buyers initially into bonds, as investors worry about Congressional hearings focused on Trump and unwinding of Trump’s anti regualtion campaign.
“The tone for business and finance changes and also could be seen as an omen for 2020. Business spending could be impacted. Equities could be down and yields could fall,” said Briggs.
As for the Fed, which begins a two-day meeting Wednesday, the election outcome would not have an immediate impact. The Fed is expected to continue to hike, unless the economy turns down or financial conditions deteriorate.
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