How The U.S. Election Outcome Could Effect Corporate Bonds

As we enter the final stage of the U.S. Presidential race, opinions and polls are being thrown around to get an early indication on the likely winner. With this being the third year of the recovery following one of the greatest recessions in U.S. history that is marred by lackluster growth and stubborn high unemployment, all eyes will be focused on the man who will lead the country back to sustainable prosperity and growth.

Today’s outcome of the U.S. Presidential election may have a significant impact on the U.S. bond market over the intermediate and longer time horizon. While economic growth is at the top of the list of priorities for both candidates, one outcome could create turmoil in the bond markets.

A Mitt Romney win will create monetary policy uncertainty. In particular, Romney stated that he does not intend to keep Federal Chairman Ben Bernanke once his term is up in 2014. He reiterated this despite his top economic advisor, Glen Hubbard, stating that Bernanke has done a “good job” and should “get every consideration” to be reappointed should the Fed Chairman decide to do so. Unfortunately for Bernanke, Romney has his sights set on a new Chairman if he wins the election.

“I would want to select someone who was a new person to that chairman’s position, someone who shared my economic views, that I thought was sympathetic to the needs of our nation,” stated Romney in an interview in August.

Furthermore, he said regarding the Fed’s balance sheet expansion in order to boost the economy, “I want to make sure that the Federal Reserve focuses on maintaining the monetary stability that leads to a strong dollar, and confidence that America is not going to go down the road that other nations have gone down to their peril.”

With the latest round of Quantitative Easing, the Federal Reserve plans to soak up a significant portion of new Mortgage Backed Securities issuance which has led to a collapse in yield for the sector. This in turn has spilled over into other assets such as Corporates and High Yield as bond investors look alternatives to add yield to their portfolios. That said, yields in credit are near historical lows.

This drop in corporate yields improves financial conditions and lowers borrowing costs even more for businesses which should improve profit margins. Lower rates, coupled with rising equity prices will hopefully encourage corporate borrowing and bond issuance that may lead to expansion, promote business investment, and increases in hiring. In the end, this action by the Fed is intended to boost economic growth which for the most part has been lackluster in the years following the Great Recession.

A Romney win at tomorrow’s election could change the current game plan. While Romney’s motive is to improve the economy, he would prefer to accomplish that through other means and away from the hands of the Fed. This in turn could reverse the recent drop in yields since investors based their strategy off the assumption that monetary policy and interest rates will remain low for an extended period of time. While it takes more than just the Chairman to change monetary policy since decisions are left up to a vote among the 12 members of the Federal Open Market Committee, the fact is that a change at the top could trickle down. This possible reality could create uncertainty among investors which may lead to selling pressure. Hence, yields in Corporates and High Yield may rise if Obama loses and Romney gets his way which should result with a new Federal Reserve Chairman in 2014.

Disclaimer: The above content is provided for educational and informational purposes only, does not constitute a recommendation to enter in any securities transactions or to engage in any of the investment strategies presented in such content, and does not represent the opinions of Bondsquawk or its employees.