Demand for Treasuries may swell if a messy outcome to the presidential election leads to flight to safety trades and could drive yields on the benchmark 10-year below 4%. The post-election period also brings the possibility of increased demand from Japan for U.S. debt.
But, an election day free of a terrorist attack and a vote that leads to a clear-cut winner without the legal battles of the previous presidential election could alone add up to 10 basis points to the yield of the 10-year Treasury, according to Ralph Axel, fixed income strategist at HSBC Securities USA. The benchmark note was at 4.08% as of last Friday.
"Getting the election out of the way will be good for equities because it will relieve the uncertainty in the market, but it will be bearish for bonds," said Mark Mahoney, a government bond trader at UBS. "There's a premium in the Treasury market due to the anxiety over any terrorist attack that might occur, and over the outcome of the election."
Conversely, a drawn-out legal battle and possible recount could cause a flight to quality trade that would seem to most benefit government bonds and may shave up to 10bps from 10-year yields, all other factors being constant, Axel said. "Both sides already have large legal teams set up. Everyone is gearing up for the fight," he said, noting legal maneuverings could take longer to play out than they did after the previous election.
Other factors may also come into play post-election. Recent comments from Japanese finance officials are indicating a growing concern over the strengthening yen, fueling speculation Japan will boost purchases of U.S. Treasuries as a currency intervention method. Last Thursday, the yen stood at 106.25 against the dollar, down from 107.48 the week before that.
But any intervention would likely come after the election and could offset a drop in demand that will probably occur if the vote goes off without a hitch. "The incumbent is struggling with weak industrial growth in the last four years, no great pick up in U.S. exports and a large trade deficit. It looks very bad if a key partner starts intervening to push your own currency higher," said Peter Franks, senior FX strategist at ABN AMRO in Chicago, explaining why any intervention and subsequent demand from Japanese authorities will likely occur after the election results are in.
Dominic Konstam, head of interest-rate strategy at Credit Suisse First Boston, expects Japan may hold off until the yen reaches 105 or even 95 against the dollar. "With the yen at 110 and Treasury yields at 4%, buying Treasuries is not a very attractive proposition," he said. He cited the relative health of Japan's economy and the possibility that China may be more flexible with its currency peg next year as reasons supporting this decision.