(Bloomberg) -- US Treasuries are better positioned to resist any selloff sparked by a decisive election victory for Donald Trump’s Republican party, given the Federal Reserve’s current policy outlook, according to Morgan Stanley.
The bank is recommending investors maintain a neutral stance on US bonds going into the Nov. 5 vote, saying the market is unlikely to react as violently as it did after Republicans won both the House and Senate in 2016. While that led to bets on much tighter Fed policy, it argues this time will be different.
“Many investors see the ‘Republican sweep’ outcome as most bearish for US Treasuries,” strategists including Matthew Hornbach wrote in a note. “We think any rise in Treasury yields would be more contained than in 2016 based on a comparison between expectations for Fed policy today versus then.”
Two and 10-year yields rose more than 50 basis points in the month following the 2016 vote, when the clean sweep handed Trump greater power to cut taxes and impose tariffs. After that, both Fed officials and markets raised expectations for the Fed funds target for the next two years by 125 basis points.
This time around, Trump is campaigning on a similar platform, fanning worries among some investors that this may ignite inflation and worsen US finances. Yet Morgan Stanley thinks a similar upward adjustment to the rate outlook as seen in 2016 is improbable. Markets are currently pricing in about 140 basis points of interest-rate cuts by the end next year.
“Market participants would have to expect the Fed to stop cutting rates immediately and refrain from cutting rates through 2025 — a very unlikely outcome under a ‘Republican sweep’ election scenario,” they wrote.
The Fed delivered its first rate cut of this cycle in mid-September, taking the effective rate to 4.83%. The market is currently pricing a high chance of a quarter-point reduction in November and another four to five reductions through 2025.
Morgan Stanley says that while investors would likely increase their expected Fed funds target rate in the event of another Trump sweep, it would not be enough to “justify investing in that direction.”
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