End of reflation trade as more volatility beckons
Ariel Bezalel and Harry Richards. Head of Strategy, Fixed Income and Fund Manager, Fixed Income
Jupiter’s Ariel Bezalel and Harry Richards comment on the implications of the US election for global bond markets.

The result of the US election is still uncertain but the ‘Biden reflation trade’, which had been increasingly priced in by markets, is already starting to unwind as investors reassess risk.

Markets had been set up for a decisive victory for Biden and the Democrats. Many investors had been long commodities, short US dollar, and short US Treasuries in the hope that higher fiscal stimulus under a unified Democratic presidency and Congress would fuel growth and reflation.

But once again it seems that the polls got it wrong, and the market got ahead of itself. A Biden landslide is now out of the question. Trump’s aggressive campaigning certainly seems to have been underestimated by most market commentators. If neither party wins decisively, the prospects of effectively pushing through big fiscal stimulus becomes harder with a divided government and a low majority. At this point, a marginal Biden victory would appear to be the worst outcome for risk assets – even if they see an initial bounce – as it would likely mean protracted delays with pushing through fiscal stimulus alongside higher taxes on corporates and high net worth individuals.

Against this uncertainty, the US dollar has strengthened and US Treasuries have gained. With bond yields getting crushed, markets have fled once again to the high growth potential of the tech sector which is driving equity indices higher.

We expect heightened volatility over the coming weeks. Uncertainty is never good for risk sentiment and in our view the risk that the reflation trade continues to unwind is high. In this environment we expect the US dollar and US Treasuries to continue to strengthen as demand for safe haven investments increase. Considering how close this election is there is also a growing risk that the result is contested. This will undoubtedly add to the volatility. A marginal victory by either party will leave a vast chunk of the US population feeling somewhat disenfranchised leading to further societal problems.

Looking out longer term, regardless of the eventual victor any fiscal stimulus package will likely be subject to delays and obstructions, with a gap between when it is most needed and when the legislation is passed. Moreover, any real economic impact from higher fiscal spending is likely to be short-lived and won’t lead to the reflation story that many are hoping for: the higher the public debt, the less impact government spending has on an economy. Tensions with China seem likely to escalate either way: a resumption of the trade wars under another Trump term can be expected, while Biden appears keener to address human rights issues. Meanwhile, more extreme monetary policy is on the horizon no matter what, further exacerbating deep societa