Bond Market Braces for Election
Outcome
By Elizabeth Roy Stanton
Senior Writer
11/6/00 9:17 PM ET
If there's a big market reaction to the outcome of
Tuesday's presidential and congressional elections, it
probably will start in the Treasury market.
The Treasury market is where benchmark interest rates
are set -- depending in large measure on expectations
for the supply of Treasury bonds, notes and bills.
For most of the last 25 years, the question about the
supply of Treasury securities has been: How much will it
grow? The federal government ran budget deficits, and it
plugged them by issuing Treasury securities. Growing
deficits and increasing supply of Treasury securities
kept pressure on their prices. Bond prices didn't always
fall, because they depend on more than just supply, but
when they fell, benchmark interest rates rose.
This time, the question is
different. In 1998, the federal
government stopped running
deficits and started running
surpluses. And it has been
using the surpluses to pay
down debt by conducting buybacks of long-maturity
issues, and by issuing fewer new securities than it has
old ones maturing.
As a result, the portion of the national debt that takes
the form of Treasury securities outstanding has started
to decline. The smaller supply of Treasury securities has
increased their value, lowering benchmark interest rates
by lowering yields.
And so the question this time around is: How much of
the projected surpluses will survive the next
administration? "For financial markets, the key question
for this election is: What happens to the surplus?"
Lehman Brothers economists Ethan Harris and Joseph
Abate wrote in a recent report.
If there is a big reaction in the Treasury market to the
outcome of the elections, it will be dictated by the
assumptions people are making how the various
possible outcomes will affect the projected surpluses.
Fondest Hope: Gore and a GOP Congress
The best outcome for the Treasury market, many
economists and bond market analysts say, would be for
Democrat Al Gore to win the presidential election and
for Republicans to maintain their majorities in Congress.
A Democrat in the White House and Republican control
of Congress is the recipe that produced the surpluses,
and that is likeliest to preserve most of them, experts
say.
Any combination involving a Gore victory is probably
better for the Treasury market than any combination
involving a victory for Republican George W. Bush,
economists and bond market watchers say.
That's based partly on precedent. UBS Warburg
economists Maury Harris and Susan Hering point out
that interest rates on average have been higher under
Republican administrations. "History says that the fixed
income markets should be more troubled if Republicans
grab the presidency," they write.
But it's also based on the candidates' specific
proposals. Both Gore and Bush would run smaller
surpluses than are currently envisioned because they
would both increase spending and lower taxes. But bond
market analysts say the surpluses would be smaller
under Bush than under Gore, because Bush is also
proposing a plan to divert a portion of the Social Security
payroll tax into private investment accounts.
Without any changes in current rates of spending and
taxation, the federal government would run surpluses
totaling $4.6 trillion over the next 10 years, according to
the Congressional Budget Office. Regardless of who
wins the election, the actual totals will probably be
smaller. "Simply put, the current size of the surplus
represents an irresistible temptation for politicians,"
Barclays Capital economist Henry Willmore said in a
research note.
But Merrill Lynch government bond strategists Gerry
Lucas and Joe Shatz estimate that the projected
surpluses will be $300 billion to $400 billion lower under
Bush than under Gore. "Obviously, these differences in
cash flows would have major implications for the
buyback program and the scarcity premium factored into
Treasury prices," they write.
Bond investors, UBS Warburg's economists say, believe
that Bush's plan "would force the Treasury to scale back
debt buybacks, lifting bond yields." By that logic, a Gore
victory could give Treasury prices a boost, lowering
interest rates, while a Bush victory could trigger a
bond-market selloff, raising interest rates.
Scariest Outcome: The Sweep
The market reactions won't necessarily be sharp,
however, unless the victor's party also gets control of
Congress -- particularly of the House, where tax and
spending bills originate, experts say.
"Gridlock in Washington has helped ensure the
continued piling up of surpluses," the Lehman
economists note. "The biggest risk to this outlook is a
clean sweep by one of the parties, [which] could be
taken as a mandate to implement campaign promises
aggressively." Bond investors would anticipate not only
that buybacks would be curtailed, but also that
stimulative fiscal policies -- tax cuts and spending
increases -- would be countered by the Fed with more
restrictive monetary policy (i.e. a higher fed funds rate),
in order to keep inflation in check.
"The strongest potential adverse bond market reactions
probably would come with strong presidential and
congressional victories for either the Democratic or
Republican parties," UBS Warburg's economists agree.
Another Possibility: The Blank Stare
At the same time, there are plenty of reasons why the
markets shouldn't react to the election outcome,
regardless of what it is, economists and bond market
analysts say.
Even if the same party wins the White House and
Congress, the closeness of both races in the polls
suggests that the election is unlikely to produce a clear
mandate, some say.
"In the absence of a major landslide and congressional
sweep, a certain amount of legislative gridlock is likely
to persist," says Ken Mayland, chief economist at
ClearView Economics. "Hence, the bias will be to
sustain large budget surpluses, which is to say, the
national debt will continue to be rapidly paid down."
Reacting to Tuesday's results, UBS Warburg's
economists note, assumes that the victor's policies will
be enacted. "Market participants would be wise," they
say, "to maintain a healthy sense of skepticism" about
that. In any event, these things take time, they point
out. For example, tax cuts probably won't take effect till
2002.
Perhaps the best reason for bond investors to refrain
from moving the market in reaction to the election
results is that they haven't proven particularly adept at it
lately, Barclays' Willmore says.
In 1992 and 1994, it took the bond market six months to
price in the tightening of fiscal policy that those
elections brought about. The precedents suggest,
Willmore says, that "the reaction will not come
immediately after the election but rater over a period of
months as the market assesses how serious [the victor]
is about implementing the program he campaigned
upon." |
