Where Rates are Headed Post-Election

Slatt Capital is tasked with addressing questions clients have about where our team thinks rates are heading. Since commercial real estate rates are closely correlated to the global bond market, we often play the role of armchair economists to properly guide our clients in their financing decisions. .

In light of the recent election season and the long term effects of Fed policy on rates, this week’s article is meant to help illuminate our thinking on these matters affecting borrowers. 

The Historic Effect of U.S. Presidential Elections on U.S. Treasury Yields

U.S. presidential elections capture the attention of millions, not only for their political implications but also for the profound economic impact they tend to have on financial markets. Among these impacts, shifts in U.S. Treasury yields are particularly notable. As bonds issued by the U.S. Treasury, these yields are heavily influenced by investor sentiment, economic expectations, and perceived risks—all factors that come under scrutiny during election years. It is wise to explore the historical relationship between U.S. presidential elections and Treasury yields, noting the dynamics at play and what history may suggest about future election cycles.

Why Treasury Yields Matter in Election Years

U.S. Treasury yields are often considered a barometer of market sentiment. They represent the return on investment for the safest debt instruments in the world, and they’re sensitive to a wide range of factors, from Federal Reserve policy to global economic conditions. Because Treasury yields respond to changes in the economic outlook, they are closely watched during election years when uncertainty tends to peak.

Investors often view presidential elections as turning points for the U.S. economy, anticipating shifts in fiscal policy, regulatory changes, and new economic priorities that could influence inflation, growth, and federal spending. Since U.S. Treasury bonds are sensitive to these factors, election cycles can become a period of yield fluctuation, as markets react to both the actual election outcome, as well as the shifting probabilities leading up to it.

The Election Cycle and Treasury Yields

Historically, U.S. Treasury yields have exhibited a pattern of increased volatility in the months leading up to a presidential election. During election years, uncertainty around potential policy changes can lead investors to either flock to or shy away from Treasury securities. Here are some key points in how this cycle typically plays out:

1. Pre-Election Uncertainty: In the months preceding an election, investors often grapple with uncertainty over which candidate will take office and what their economic policies will look like. As a result, investors may take a “wait-and-see” approach, leading to lower trading volumes and potential increases in yields as demand for Treasuries fluctuates. In some cases, such as in 2016 and again in 2024, this pre-election uncertainty led to a spike in yields as investors anticipated economic upheaval.
2. Election Results and Immediate Reaction: Once the election results are announced, markets react almost immediately, with Treasury yields either rising or falling based on the anticipated impact of the new administration’s policies. For instance, in 2020, yields briefly dipped as the uncertainty of the election outcome was compounded by the COVID-19 pandemic, leading investors to seek safety in Treasuries. However, as it became clear that a fiscal stimulus was imminent, yields soon rebounded. As of this morning, Treasury yields across the curve have reached new recent highs as the market absorbs the incoming administration’s early leadership picks as well as the elevated CPI print from last week, and renewed concerns over sticky inflation drive a flight to safety. It’s early days, but the market may be at least temporarily frosting on the belief that the dollar will strengthen and the U.S. economy will materially improve under a Trump administration.
3. Post-Election Economic Policies and Market Sentiment: After the election, the actual policies enacted by the new administration start to shape economic expectations. These policies—ranging from tax reforms to infrastructure spending—can have a significant impact on the federal deficit and economic growth, which in turn influence Treasury yields. For example, the tax cuts enacted after the 2016 election were expected to stimulate growth and increase inflation, leading to an increase in yields in anticipation of stronger economic performance and higher inflation.

Historical Examples of Elections Affecting Treasury Yields

The Reagan Era (1980)

When Ronald Reagan won the 1980 election, his economic platform focused on significant tax cuts and increased military spending. Markets anticipated higher deficits and inflation, causing yields to rise as investors expected more aggressive borrowing by the government. The yield on the 10-year Treasury bond increased from around 10% in early 1980 to 15% by mid-1981. This significant shift underscored the impact of anticipated fiscal policy changes on Treasury yields.

The Clinton Years (1992)

In 1992, Bill Clinton’s election saw a shift toward fiscal discipline, with an emphasis on reducing the federal deficit. Clinton’s policies helped reduce the deficit and boost investor confidence, which contributed to a decline in Treasury yields. The 10-year Treasury yield, which was around 7% in 1992, trended downward over the next several years, highlighting how expectations of a more balanced budget and fiscal restraint can reduce upward pressure on yields.

Trump’s Election and the “Trump Trade” (2016)

The 2016 election of Donald Trump triggered what was called the “Trump Trade,” with expectations for massive tax cuts, deregulation, and infrastructure spending. Investors anticipated these policies would stimulate growth, increase inflation, and necessitate higher interest rates. Yields on the 10-year Treasury spiked from around 1.8% before the election to nearly 2.6% by the end of the year, reflecting an increase in growth and inflation expectations. Yields remained elevated until late 2019 when the global threat of the pandemic began to set in, and aggressive monetary policy began trying to save the global and U.S. economy from the significant pressures of shutdowns and supply chain constraints.

Biden and the Pandemic Economy (2020) 

The 2020 election took place amid the COVID-19 pandemic, and Treasury yields were initially low due to the Fed’s aggressive easing measures and a bleak economic outlook. When Joe Biden won the presidency, expectations for additional stimulus and an economic recovery were high, which put upward pressure on yields. In early 2021, yields began to rise in anticipation of significant federal spending and a recovering economy, moving from around 0.9% in November 2020 to over 1.7% by March 2021, with treasuries spiking close to 5% in the fall of 2023 close to peak inflation and right as the Federal Reserve began easing off the breaks by raising the Federal Funds rate.

Key Drivers Behind Election-Related Movements in Treasury Yields

Several factors contribute to the effect of presidential elections on Treasury yields:

–Fiscal Policy: Anticipation of increased government spending or tax cuts can raise inflation expectations, driving yields higher as investors seek compensation for expected inflation.

– Federal Reserve Policy: The Fed’s monetary policy stance often plays a major role in determining Treasury yields. In election years, the Fed may become more cautious with policy changes to avoid appearing politically motivated.

– Inflation Expectations: Markets often react to election promises by pricing in future inflation risk. Policies expected to stimulate the economy can lead to higher inflation forecasts, which, in turn, push Treasury yields up.

What to Expect in over the next 12 months:

While each election cycle is unique, a few general patterns tend to hold:

1. Initial Volatility: Treasury yields are likely to experience heightened volatility in the coming months as the global market absorbs policy proposals of the incoming administration.
2. General Trend to the Mean: Once markets settle in for the next four years and it’s clearer what the new administration is likely to accomplish, that new field will allow investors to make decisions that will allow liquidity to flow more consistently. If a roaring economy becomes the thesis, Treasury yields, especially on the long end of the curve, are likely to remain elevated relative to the lower average levels seen in 2021. Alternatively, if recession is on the horizon and stimulus is necessary, Fed policy adjustments along with a flight to safety could drive Treasury yields lower. In either case, a base-case of the classic CPI + 1.5% = 10-year yield formula should be tracked.
3. Other macro trends will continue to influence Treasury yields as well: Demand for Treasuries, particularly appetite from foreign governments, will directly influence yields. Investor risk appetite, availability of alternative investments, yield requirements on regular savings accounts, potential for watershed events, and more will also contribute to yield movements. 

Conclusion

Presidential elections are pivotal events that can significantly influence U.S. Treasury yields and by extension our commercial real estate interest rates. By understanding the historical context, borrowers and financial intermediaries can better anticipate how market sentiment and economic expectations might shift with each election and try and plan interest-rate decisions accordingly.

While no two election cycles are identical, the patterns of pre-election volatility, immediate post-election adjustments, and longer-term policy-driven movements provide a valuable framework for understanding the impact of politics on Treasury yields.