U.S. Bond Investors Navigate Cautiously Amid Election Uncertainty
As the Federal Reserve's policy meeting this week approaches its conclusion, bond investors are adopting a cautious and neutral stance in portfolio management, shadowed by the U.S. presidential election's potential impact on the Fed's anticipated decisions. With the Federal Open Market Committee's two-day meeting, postponed due to Tuesday's election, set to conclude on Thursday, a 25 basis point reduction in the benchmark interest rate is expected, lowering it to a range of 4.50%-4.75%.
Investors have been focused more on the election than the Fed meeting in recent weeks. As the election outcome remains uncertain, investors are behaving cautiously in their investments. Throughout the year, bond investors have lengthened their portfolio durations in anticipation of the Fed's interest rate cuts and a possible recession. This strategy continues to dominate the bond markets post-election.
If interest rates decrease, bond prices are expected to rise, with long-term bonds typically performing better than short-term assets during periods of rate cuts. Brendan Murphy, head of North American fixed income at Insight Investment, which manages $838.1 billion in assets, stated, "We have taken some small long positions on the yield curve, but overall we are closer to neutral." Murphy emphasized that the uncertainty surrounding the election is a factor in their cautious stance, indicating a wait-and-see approach.
Similarly, Janet Rilling, senior portfolio manager and head of the Plus Fixed Income team at Allspring Global Investments, noted that the Fed's dependence on data, the volatility of U.S. economic data, and the election have dictated their neutral position. Rilling expressed a preference for a reactive strategy that allows for reassessment post-election.
Recently, the futures market has seen position liquidations among institutional investors, reflecting a cautious sentiment ahead of both the election and the Fed meeting. Asset management firms typically employ long contracts in Treasury futures to meet portfolio needs.
According to Commodity Futures Trading Commission data, asset management firms have decreased their net long positions in U.S. 10-year Treasury futures from record levels on October 1. Other market participants in Treasury futures have also reduced their excessive positions in recent weeks.
Volatility has risen with election expectations, and the MOVE index, which measures interest rate volatility, reached a high of 135.18 last Thursday, marking its highest level in over a year. This suggests that Treasury yields could fluctuate significantly in the near term. Harley Bassman, creator of the MOVE index and managing partner at Simplify Asset Management, indicated that option prices foresee significant moves in Treasury yields around November 6 or 7.
The election race between former Republican President Donald Trump and Democrat Vice President Kamala Harris remains competitive, with recent online prediction markets showing that Harris is gaining momentum and the gap is narrowing.
In the bond market, a trend referred to as the "Trump trade" has emerged since last month, where investors sell bonds amid expectations of inflationary pressures and rising fiscal deficits stemming from Trump's economic plan, leading to increased Treasury yields.
Despite rising yields and volatility, most investors are avoiding making significant moves. However, some see current market conditions as an opportunity to make strategic investments before the election results are finalized.
Clayton Trick, head of public strategies portfolio management at Angel Oak Capital Advisors, which manages $17 billion in assets, noted that agency mortgage-backed securities are attractive due to typically offering higher yields compared to Treasury bonds.
Rilling from Allspring also pointed out that with the recent rise in yields, investors might gradually transition from cash assets to short-term assets and then to medium-term ones, or shift into longer-term assets.