How to benefit from the US elections in the context of bonds? 3 scenarios

Po presidential debate it is clear that volatility monetization should be strategically approached in the context of the US election. We analyzed three scenarios: Trump's victory, Biden's victory, and contesting the election result. In this context, we analyze the risks and opportunities in the fixed income investment market.

About the Author

Althea Spinozzi, Marketing Manager, Saxo Bank. She joined the group Saxo Bank in 2017. Althea conducts research on fixed income instruments and works directly with clients to help them select and trade bonds. Due to his expertise in leveraged debt, he focuses particularly on high yield and corporate bonds with an attractive risk-to-return ratio.

1. WON BIDENA

Yield curve: short-term bullish flattening, long-term bearish uplift

In the scenario of Biden's victory, we expect a moderate flight to safe investments in the short term, which will translate into an even greater decline in profitability. We are convinced that because the market underestimates the risk of inflation, interest rates are likely to fall as close to zero as possible if a correction in the market is allowed in the event of the election of a democratic president. Volatility will emerge as Biden's victory will be seen as unfavorable to the corporate bond market due to higher corporate taxation and tighter regulation. This scenario does not have to be negative for the corporation, however, as the Fed will continue to provide massive support to stimulate the economy.

In addition, we predict an increase in general public spending, which will indirectly positively affect the corporate world as individuals start spending money. It is crucial to understand that a bullish flattening yield curve will only be a temporary reaction to an election. In the long run, a Biden win generally means higher interest rates. The increase in public spending is putting further pressure on the economy, which will translate into higher inflation. When inflation begins to rise, the process is unstoppable for a simple reason: political circles will be reluctant to withdraw aid to American families. Hence, in the longer term, the yield curve will rise sharply as inflation rises.

Corporate bonds: green bonds

In the short term, we expect high-investment long-term corporate bonds to benefit from post-election volatility. Long-term FAANG bonds (Facebook, Apple Lossless Audio CODEC (ALAC),, Amazon, Netflix, Google), in particular in view of the continued spread of Covid-19. Taking into account the individual issues, we expect that Apple bonds maturing in August 2060 (US037833EA41) and Amazon bonds maturing in June 2050 (US023135BT22), yielding around 2,5%, may strengthen in as a result of Biden's win. In both cases, the advantage over government bonds is around 100 basis points.

Investors looking for higher returns can choose from a variety of noteworthy investment grade long-term bonds. FedEx 2065 (US31428XBD75) offers a yield of 4% and approximately 260 basis points ahead of government bonds. In the area of ​​lower investment rating, we have General Motors 2043 (US37045VAF76), with a profitability of around 5%.

It is worth noting that we see the benefits of bonds with these characteristics only in the form of an "election investment", and the holding period should not exceed the end of 2020. In fact, after the first increase caused by Biden's victory, we do not expect any major benefits from holding bonds with ultra-long maturity. In our opinion, inflation will increase, which will cause a correction of the bond market valuation, first of all long-term ones.

We believe that in the long term, high investment grade medium-term corporate bonds will provide investors with asset security and stable returns. However, this segment is seriously threatened by the risk of inflation, mainly due to the fact that the average profitability in this area is around 1%. Therefore, when considering this segment, higher yields or hedging against inflation should be sought. Among the mid-term investment-grade US corporate bonds, we chose General Motor 2028 (US37045VAS97), Micron Technology 2029 (US595112BN22) and British American Tobacco 2027 (US05526DBB01) as those that will yield well above 2%.

In the area of ​​lower investment grade corporate bonds, it should be recognized that this segment will be highly volatile. Many of these companies face the risk of downgrading as their credit ratings deteriorate following massive issuance of debt.

The real winner in the event of Biden's victory, however, will be green bonds. Green bonds are fixed income instruments designed to finance a specific climate or environmental project. Clean energy and environmental issues were neglected during Trump's tenure, and are a pillar of Biden's campaign.

Green Bonds will benefit significantly from the Democrat's presence in the White House, primarily because demand will continue to grow, but supply will remain limited.

2. TRUMPA WON

Yield curve: bearish swell

Trump's victory will be seen as beneficial for corporate bonds. It can be assumed that in the second term of office the current president will continue the activities from previous years: tax cuts, deregulations and the expansion of the fiscal budget. As a result, investors will turn to riskier assets in search of additional profitability exceeding the yield on treasury securities. While this behavior will cause a bull market in the short term, leverage levels will prove unsustainable in the long term. The immediate effect of Trump's win for the US yield curve will be a slight increase in the interest rate on bonds with longer maturities. Higher yields will reflect the risk appetite in the market and an increase in inflation expectations. As in the Biden win scenario, the short end of the yield curve will not change due to the curve control by Fed.

Corporate bonds: bonds of energy and financial companies

In the area of ​​corporate bonds, there will be a repeat of the situation from 2016 to today. Companies that will benefit from lower taxes and deregulation will provide the most profit under this scenario. Contrary to the Biden scenario, we tend to bulge the curve (maturities ranging from five to seven years) in order to avoid volatility at the long end of the yield curve. Longer maturities will be more volatile due to Trump's aggressive foreign policy and inflation expectations. Energy and finance companies are our preferred sectors. In this area, you can find investment grade bonds that offer a significant advantage over government bonds, such as the bonds of BGC Partners, a US-based financial broker, maturing in 2024 (US05541TAM36), providing approximately 320 basis points ahead of government bonds in the case of a BBB- rating. Similarly, bonds of KKR Capital, a US investment firm, offer a 400 basis point advantage over government bonds (US302635AD99) for a lower investment rating (BBB- / Baa3).

High yield bonds will also benefit from Trump's victory. In this area, our preferred sectors are those that underpin Trump's campaign: finance, energy, construction, domestic manufacturing, and defense. In our opinion, however, it is worth choosing corporate bonds carefully so as to avoid overvalued assets and optimize the risk-reward ratio due to the constant increase in bankruptcy risk.

3. CONTESTING THE RESULTS OF THE ELECTIONS

Under this scenario, which seems most likely at this point, there will be a sudden and sustained spike in volatility. Corporate bond spreads will widen and security will be key. The US yield curve will record a bullish flattening over the period of the election results being contested. Under the worst-case scenario, government bonds may even fall below zero. In the corporate area, quality will become a priority, and the strengthening will only apply to high-quality companies. It is worth noting that once the winner is announced, the market will normalize and the yield curve will start to uplift to accommodate inflation.

Coronavirus - an external electoral factor

Keep in mind that the US elections are not the only variable affecting investors' portfolios. Coronavirus will also continue to be an important factor. Therefore, it should be borne in mind that some sectors will continue to perform well due to the pandemic. Healthcare, digital economy and digitalisation represent a niche that will continue to be won due to Covid-19. In this area, Netflix's bonds maturing in 2025 (US64110LAL09) and a yield of around 2% appear quite interesting, even though they strengthened significantly since issuance. Opportunities can also be found in the food and drink sector, which is crucial for the government in times of the pandemic. Kraft Heinz bonds (US50077LAK26) with maturity in 2025 and yield of 1,8% look favorable in this area. Even during a lockdown, people will buy ketchup, right? Consider B&G Foods bonds maturing in 2025 (US05508RAE62) with a yield of around 3% and Pilgrim's Pride bonds 2025 (US72147KAC27) offering a yield of around 4%.

In contrast, some sectors will suffer losses as a result of further movement restrictions caused by the pandemic. Avoid airlines, retail stores, and recreational activities as they currently generate almost zero income.