Indiana Trust Wealth Management
Investment Advisory Services
by Clayton T. Bill, CFA
Vice President, Director of Investment Advisory Services

  • The U.S. equity market, represented by the S&P 500 index, fell 1% for the week.
  • Long-term interest rates have risen in recent weeks. Is the upcoming election playing a factor?

Back in mid-September, it seemed clear that the Federal Reserve leadership’s forward guidance (their interviews, committee minutes, jawboning, etc.) pointing to interest rate cuts had successfully begun to lower interest rates. The 30-year mortgage rate had dropped to a 12-month low (6.1%) and the 10-year Treasury note had eased down to 3.6%. The Fed proceeded to cut its target rate by half a percent, a big move for the Fed, and it felt like the interest rate downtrend had begun.

Fast forward to the current day, and the 30-year mortgage rate is pushing 7% and the 10-year Treasury has popped to over 4.2% The rise in interest rates feels counterintuitive to a Federal Reserve that is in outsize rate-cut mode.

The Fed operates and directly controls the very short end – the overnight part – of the yield curve. Interest rates going out one year, two years, or ten years can be thought of as a series of short-term interest rates linked through time. In this framework, what matters most for long-term interest rates are expectations for future short-term rates – or what Fed policy will be in the future.

This is very difficult to discern.

To fill this void of knowledge, economists and asset managers have offered many explanations for the recent rise in long-term interest rates. Some claim it is an increase in the “term premium”, a premium that long-term bond investors demand to compensate for the uncertainty of the Fed’s future interest rate decisions.  

In a research note this week, JP Morgan connected the idea of a rise in term premium with the possibility of a second Trump administration. Trump’s policies may be viewed as inflationary, thus future Fed decisions may call for higher interest rates, which would be bad for current bondholders. When interest rates rise, bond prices fall.

Joe Weisenthal at Bloomberg makes two salient points about the view that the market’s accounting for a Trump presidency is pushing up the term premium and interest rates. First, leading up to the 2016 election, the consensus view was that a Trump win would be bad for stocks. On election night as it became clear that Trump would win, futures sold off sharply. Subsequently, stocks did just fine. The conventional wisdom on how elections impact markets can be plain wrong.

The second, more nuanced point is that Americans do not like high interest rates. One American who has been on the record with a vociferous dislike of high interest rates is Donald Trump, a former property developer. What if Trump’s economic policies do stoke inflation? Rekindled inflation and resultant high interest rates could present political constraints for some of those policies. Of course, those same constraints would exist for Kamala Harris’s spending proposals.

The recent rise in long-term interest rates may reflect the bond market positioning for both election outcomes, a reflection that neither party has made deficit reduction a core tenet of their platforms.

__________

IMPORTANT DISCLOSURES: All info contained herein is solely for general informational purposes. It does not take into account all the circumstances of each investor and is not to be construed as legal, accounting, investment, or other professional advice. The author(s) and publisher, accordingly, assume no liability whatsoever in connection with the use of this material or action taken in reliance thereon. All reasonable efforts have been made to ensure this material is correct at the time of publication.  Copyright Indiana Trust Wealth Management 2024.