Jim Cielinski, Global Head of Fixed Income, believes central bank policy is likely to be the dominant influence on fixed income markets, regardless of who wins the US election.

  Key takeaways

• President Donald Trump and Democratic nominee Joe Biden have divergent economic policies. But the specific impact of these policies – what actually gets implemented – will not be known until long after election night, a caution against making immediate shifts in a fixed income portfolio.
• Markets are expecting volatility to be high around the election but subdued in most other periods as a result of the US Federal Reserve’s commitment to low interest rates. Thus, following the election, we expect the search for income to continue in bond markets.
• Against this backdrop, mortgages, asset-backed securities, collateralised loan obligations and corporate credit could remain attractive, almost irrespective of the election outcome.

Transcript

Jim Cielinski: I think whenever you have a big event like an election right in front of you, most investors are concerned about what it means for their portfolio. What are the scenarios that might play out? What will bond yields do? What do equities do? And it’s important to realise that you not only have to predict the outcome of the election, you also have to predict what that means for markets. And it is really the second part of that that trips people up quite frequently; the knee-jerk reaction that you often get is the wrong one. You have to look at what will be implemented versus what is proposed. You have to look at the chances of implementation as well. Will we get a clean sweep? Because without a clean sweep, the impetus to actually make material change is actually quite limited.

When trying to assess how to invest under each of the different scenarios, I think with Trump, it is more predictable. It will be more of the same, expect further deregulation, more easy money and big deficits. But again, we know that outcome. The Democratic platform, I think will attempt to undo a lot of what Trump has done by imposing tax increases on the corporate sector and trying to shift sectorally through spending: a focus on infrastructure, a focus on green energy and also on higher minimum wages. So, what you’ll see is maybe GDP [gross domestic product] not change that much, but how it is distributed from corporates to individuals, I think you should expect that to change.

I think if we had a change in administration, you should look at the economic policies. There should be lower trade frictions and that would be good, say, for exporters but it should also be good for emerging markets. You should look at what the key platform initiatives are. Clean energy or infrastructure, those companies that benefit from that should do well. Perhaps those like banks that have been the beneficiary of deregulation should do less well. Again, a lot of dispersion will be priced in, a lot of dispersion will play out and a lot of dispersion we won’t even know for some time after the election.

When faced with uncertainty, I think it is always important to ask which areas of the fixed income market can do well across different scenarios. Volatility is expected to be high around the election, but markets are pricing in low volatility in most other periods. So, once we get through the election, we would expect close to zero rates coupled with low volatility to continue producing that search for income. Moving down the liquidity spectrum into mortgages and asset-backed [securities] and CLOs [collateralised loan obligations], for example, I think is interesting. And in the more mainstream markets, [I think] credit should actually do quite well. And that is even true in a slow-growth, low-inflation environment or a more rapid growth environment that would be brought on by higher spending.

I think there is a fixation on the election because it is interesting and it is so near. But there are so many things going on in the world today – the debate on inflation, or what does trade policy do? What happens if we get a vaccine? All these questions are really meaningful for markets, and so I don’t think we should get fixated on just the election because a lot of things are driving markets today and it is really the interplay of these that will determine how you should invest.

 

Notes

Collateralised loan obligation: This is a structured finance product in which loans from different businesses are pooled together and sold to different classes of investors in various tranches. The different tranches carry different yields, with investors receiving higher yields in exchange for being earlier in line for absorbing any losses should the underlying businesses behind the loans fail to meet their repayments.
Green or clean energy: Energy production or energy consumption that is focused on sustainability, for example energy from non-fossil fuel, renewable sources.
Inflation: The rate at which the prices of goods and services are rising in an economy. The opposite of deflation
Volatility: The rate and extent at which the price of a portfolio, security or index, moves up and down. If the price swings up and down with large movements, it has high volatility. If the price moves more slowly and to a lesser extent, it has lower volatility. It is used as a measure of the riskiness of an investment
Yield: The level of income on a security, typically expressed as a percentage rate. For a bond, at its most simple, this is calculated as the coupon payment divided by the current bond price.

These are the views of the author at the time of publication and are subject to change.