October 26, 2020 BARRON’S 7
UP & DOWN WALL STREET
BCA Research sees an 80% probability of an
election result that will lift yields via stimulus,
causing a “moderate bear market” for bonds.
Are Rising Yields a
Good Sign or Warning
For the Economy?
reversing. The populariShares 20+
Year Treasuryexchange-traded fund
(ticker: TLT) broke its bullish trend
by falling below its 200-day moving
average for the first time since 2018,
according to Bespoke Investment
Group.
BCA Research’s bond strategists
blame politics for this key reversal.
“We estimate that there is an 80%
probability of a U.S. election result
that will give a lift to U.S. Treasury
yields via increased fiscal stimulus,”
they write in a client note. That would
give rise to a “moderate bear market”
in bonds over the next six to 12
months, they add.
Or as Renaissance Macro sums up
its playbook: Democrats win, leading
to more government spending and
higher growth expectations, leading to
a rise in long-term interest rates, with
a steeper yield curve (the difference
between short- and long-term rates).
BCA bases its forecast on its esti-
mate of a 45% probability of a Demo-
cratic sweep of the White House and
the Senate, which would lead to “un-
fettered stimulus in 2021” but a “nega-
tive shock” to profits from increased
corporate taxes and regulation. The
second-most-likely scenario, with a
30% probability, would be Trump’s
re-election, with the Republicans
retaining control of the Senate. This,
BCA predicts, would result in less
fiscal stimulus but the risk of height-
ened trade wars, not just with China,
but also with the European Union, the
advisory service says.
A Biden win, combined with a GOP
Senate, has a 20% probability but
would be the most positive outcome
for financial markets, BCA says, with
lower odds of a full-scale trade war
with China and no tax hikes. A
Trump victory with a Democratic Sen-
ate has just a 5% probability, which
could lead to big populist spending
with no tax boosts, and the continued
risk of U.S.-China trade conflicts.
Both Trump and Biden would
substantially boost federal debt, by
$4.95 trillion and $5.60 trillion, re-
spectively, by 2030, according to
projections cited by BCA from the
Committee for a Responsible Federal
Budget. But Biden would ramp up
spending by more than twice as
much, by $11.1 trillion versus $5.
trillion by Trump. The Democrat
would boost federal revenue by $5.
trillion through tax hikes on corpora-
tions and upper-income households,
while the GOP would have $750 bil-
lion in savings.
The Democratic plan would be
more reflationary by putting addi-
tional money in consumers’ pockets
to spend, BCA contends. Based on a
Moody’s forecast, the economy would
reach full employment by the second
half of 2022 under a Biden adminis-
tration, and in the first half of 2024 if
Trump is re-elected.
Such long-range forecasts, of
course, should be taken with a big
chunk of salt. What seems reasonable
is to expect some lift in bond yields
from their historic low levels. Just a
return to normalcy, once a vaccine
is developed and widely available,
ought to raise yields from their pre-
ternaturally depressed levels. Ramp-
ing up federal spending for infra-
structure, child care, education, and
other purposes, as Biden proposes, at
a minimum means that the Treasury
would be auctioning more notes and
bonds.
The countervailing force comes
from the Federal Reserve, which is
likely to maintain its near-zero short-
term interest-rate target out to 2023.
At the same time, the central bank
has been buying $80 billion of Trea-
suries and $40 billion of agency
mortgage securities per month in its
quantitative-easing campaign, damp-
ening upward pressure on yields.
BCA suggests that the bond market
could push up longer yields “to chal-
lenge the Fed’s forward guidance” on
rates, however.
The yield curve’s slope, as repre-
sented by the spread between the two-
and 10-year notes, has steepened to
70 basis points, the most since 2018.
(A basis point is 1/100th of a percent-
age point.) That was a much different
time and place, however. The bond
market then was anticipating contin-
ued Fed increases in its federal-funds
By Randall W.
Forsyth
Would a victory by
former Vice Presi-
dent Joe Biden over
President Trump
be reflationary
by putting more
money in consum-
ers’ pockets?
W
ill a Blue
Wave swamp
the bond
market? The
prospect of
the Demo-
crats win-
ning both the White House and the
Senate to add to their control of the
House of Representatives continues
to be viewed with equanimity by the
stock market. As suggested in this
space a week ago, however, equity
investors should be careful of what
they wish for.
The bond market also appears to
be anticipating the eventual enactment
of more forceful stimulus in a Demo-
cratic sweep by pushing up longer-
term Treasury yields, which translate
into lower bond prices. The question
is whether this uptick is a positive
portent of a sustainable recovery, or
a warning sign for an economy that
depends on the twin stimulants of
ultralow interest rates and record
peacetime fiscal deficits.
So far, the upward drift in bench-
mark longer-term Treasury yields,
which set the pace for many borrow-
ing costs, has been mild. But if it con-
tinued, it would represent a change
in a long trend toward lower rates.
It also would be one that the Federal
Reserve might resist by attempting
to cap yields at the long end of the
market.
The yields on the benchmark 10-
and 30-year Treasuries rose steadily
in the past week, to 0.85% and 1.63%,
their highest respective levels since
early June. In price terms, meanwhile,
Drew Angerer/Getty Imagestheir upward trend appears to be