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Is the US still the land of the ‘risk-free’?


While a chaotic 2020 election adds to short-term uncertainty for US bond investors, both candidates’ promises point to more long-term government borrowing

Even in a world gripped by a global pandemic and with the seasons now against us, the battle for the White House is a major event for investors. No wonder, then, that the biggest event for bonds, currencies and markets for the rest of 2020 is very likely going to be the US presidential election on November 3.

The US, hit hard by Covid-19, seems to be a country disunited. There are glaring disparities from state to state in terms of wealth, and stark contrasts in demographics from east to west and north to south. The two candidates are also poles apart compared to previous elections. For us, as investors, this makes for a very interesting, albeit volatile, next few months.

There are some similarities, of course. The incumbent Republican President Donald Trump, and Joe Biden, the Democratic nominee and favourite (according to the polls) to become the US’s 46th president are both capitalists. They are also septuagenarians, with a combined age of over 150. There are also concerns over the health of the respective candidates. For example, Trump’s recent exposure to Covid-19 and rapid recovery raises more questions than answers. While if successful, Biden would be 78 on the day he is sworn into office (January 20 2021), and the country’s oldest-ever president.

The risks of a contested election

One scenario potentially playing out is if the outcome of the election is contested by Trump. If the result is very close, will Trump refuse to leave the White House? “We’ll have to see what happens,” the president told a news conference recently. Postal voting has also been expanded across states, to encourage social distancing, and this has also worried Trump and his supporters, because it traditionally favours the Democrats.

But as trust in the government and democratic process is the fundamental thing that stands behind currencies and bond markets, this could make things uncomfortable. As a result, the price of assets could also swing dramatically as an aversion to the US dollar and US Treasuries potentially filters through to the US credit markets too.

During 2020 we have generally ran a comfortable level of ‘risk-free’ exposure, made up of government bonds and cash, to use should assets become mispriced, providing investment opportunities along the way. Yet we prefer our risk-free to come mainly from German bunds. In this context, we think that the pandemic has added impetus to Europe’s co-ordination of monetary stimulus – yet ironically increased the friction at the state versus federal level in the US.

Both candidates have pledged to spend at a huge rate, although how this will be funded and where it will go set them apart. Trump will probably renew his pledge from his 2016 election campaign and maintain tax cuts for companies and individuals. This would mean more government bond issuance to pay for these tax cuts.

Biden, on the other hand, could take up where Trump hasn’t delivered to the scale he wanted – heavy spending on infrastructure projects – but this time with a focus on clean energy projects. Biden has also said he would re-establish Obamacare in all its glory. So far, Trump has been only partially successful at dismantling his predecessor’s attempt for wider healthcare for the population. It is likely Biden will also raise taxes to help pay for his party’s spending plans, while also turning to the bond markets for some funding, similar to Trump.

Opportunities in the election turbulence

Whoever wins the race for White House and survives this very noisy and often chaotic election campaign (the first TV debate, Trump getting Covid-19 etc), the markets will likely react in typical emotional fashion – and that, in our view, is the moment when things will get really interesting.

The views expressed in this document should not be taken as a recommendation, advice or forecast.

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