Turning of the tides. It takes only moments to alter destinies – incumbent President Joe Biden’s poor showing in the Presidential debates has led to an abrupt end in his bid for re-election. What was initially a tight toss-up between two leading candidates has now evolved into a clear lead by the Republican nominee Donald Trump. Even then, he was not without his own destiny-altering moment; the ex-President had to literally dodge a bullet in a botched assassination attempt to take pole position in this presidential race. Now that the dust has settled, it is perhaps a little safer for fixed income investors to look ahead to ascertain what a second Trump administration might imply for the markets.

Elections themselves have limited impact on credit risk. Quantitatively, the first thing to note is that credit spreads show little variance between a Republican or Democratic presidency; an intuitive observation given that other factors (corporate balance sheet strength, profitability, monetary policy, liquidity etc.) have a larger and more direct influence on spreads. Interestingly, under both sides, spreads exhibit a tendency to decline in the 12 months after elections – likely as the markets are relieved of a key quadrennial risk event.

Presidencies and the yield curve. The yield curve however does seem to show slight differences – Under Republican presidencies, curves appear to flatten in the one-year period before and after elections, while democratic presidencies see steepening in the same timeframe. Once again, the data on average shows little discrepancy between Republican or Democratic presidencies, but it is interesting to note that the ranges can be quite variable – for example, the 10Y UST yield under Republican presidencies appear to inhabit a lower range of yields two years after elections, while the range under Democratic presidencies appears quite wide.

This runs against the current consensus that a second Trump regime would almost certainly lead to higher 10Y yields due to runaway deficits and debt; one would recall that it is in fact the Republican party that historically leans towards fiscal conservatism (referencing the “Tea Party” movement of 2009). These consensus assumptions therefore warrant further investigation.

Would a Trump presidency lead to higher yields? Conventional assumptions remain that a second Trump term would pave the way for another round of unfunded corporate tax cuts, potentially aggravating the runaway US federal government debt problem that the US Congressional Budget Office (CBO) projects to reach 166% of GDP by 2054. We encourage investors to take a slightly contrarian view, given that Trump’s second term could look quite different from his first for a few reasons:

1. It is difficult to cut corporate taxes much further from here. The 2017 Tax Cuts and Jobs Act (TCJA) permanently reduced corporate tax rates from 35% to 21%. To reduce taxes by the same magnitude again would be extremely difficult, seeing that those savings did not go as far towards domestic investment as they did to fund share buybacks. It would also be much more unpopular to Trump’s voter base today to reduce taxes for multinational corporations with a liberal bias.
2. Trump prefers lower rates. In his first presidential term, Donald Trump was not uncomfortable with blurring the lines on Fed independence, overtly criticising the Fed on social media for aggressively raising rates during his term as president. With policy rates today nearly double those of his first term, it is difficult to imagine that he would be more comfortable about it now. Seeing as interest payments are a large contribution to the CBO’s debt projections, this could help to partly arrest the deficit spiral.
3. Tariffs would put a lid on potential growth of the economy. While tariffs are inflationary and could encourage re-shoring of manufacturing activity, we note that it does still result in efficiency losses that decreases potential economic growth which can ultimately lead to lower bond yields. Trump’s first term is illustrative – while tax cuts did initially supercharge expectations of strong growth and provided cover for a Fed hiking cycle, tariffs and trade tensions eventually dampened the global outlook which resulted in 10Y UST yields falling all the way down to c.1.5% even before the pandemic.

A Trump presidency is not bond Kryptonite. Based on the above, we believe that a Trump presidency may not lead to the higher-and-higher yield environment that fixed income investors fear; investors should therefore capitalise on any spike in yields to switch from cash into bonds as we pivot towards a cutting cycle in global monetary policy.