Why the U.S. Election Is a ‘Big Risk’ to Bond Yields

A Republican election sweep—or a Democratic wave—could result in more fiscal stimulus, which would likely re-accelerate inflation and slow down the Federal Reserve’s pace of interest rate cuts, according to Insight Investment’s Brendan Murphy.

The money manager is overweight on corporate credit amid a supportive technical and fundamental backdrop right now. Fund flows into the asset class are “tremendous,” the Fed’s easing policy is supportive, and companies have done a good job of terming out debt, said Murphy, Insight’s head of fixed income for North America, based in Boston.

But as the U.S. presidential election approaches, corporate credit risks are rising. “It’s a big risk to bond yields in general, but it would also be a risk to risky assets and to credit spreads because the market’s pretty fully discounted a return to normalization,” Murphy said in an October 17 interview.

Below are highlights of the conversation, condensed and edited for clarity. Insight has $838.1 billion of assets under management as of June 30, according to its website.

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Bloomberg:  There’s a lot of positive momentum for credit right now. What could go wrong from here?

Brendan Murphy:  A couple of things could go wrong. Election is a risk. There’s various forms in terms of the composition of Congress and the executive branch that could take shape that might present some volatility in markets.

Our view is that we’re going to stabilize and avoid recession, but certainly there’s a chance that the economy takes a more negative trajectory. People were going down the path of ‘Well, the labor market could deteriorate more materially.’ The latest numbers give you some comfort that maybe that’s not the case, but it’s just one number at this point. The other big risk with the election is one outcome that is not really discounted a lot: the “no landing” sort of outcome.

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Bloomberg:  Investors searching for higher yields are moving down the credit-quality spectrum. Why are you favoring higher-quality notes?

Brendan Murphy:  You’re always going to get paid more to extend out or to go down in credit quality. But the marginal benefit you get from doing that is quite small, historically. So, that’s a signal to me to actually go the other way. It doesn’t cost me much to go up in quality; why wouldn’t I just do that? The other thing that’s been important in terms of the market dynamics—and why spreads are so tight—is that a lot of the buying has been yield-based as opposed to spread-based.

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Bloomberg:  Are you surprised by the record issuance we’re seeing? Do you expect sales to slow down?

Brendan Murphy:  My guess is it’ll taper down a little bit in front of the election and then maybe you get a bit of a pop after that, depending on what the market environment looks like. The flip side is that as much as supply is robust, demand is even more robust. And that’s led to a supportive environment in terms of price action.

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Bloomberg:  Private credit funds—in particular, business development companies—are also issuing a lot of bonds. Does that worry you?

Brendan Murphy:  We typically don’t buy BDC bonds. In general, we’re not investing in private debt. When I go to various conferences, there’s a lot of air time around private debt, and there’s a lot of money flowing into that market. The worrisome aspect of it is being a less-liquid part of the market, with less visibility.

We’re obviously in a supported credit environment right now, but if that credit environment were to deteriorate, you’d worry about potentially some excesses in those sectors and how that might spill over into the more traditional public market. So it’s somewhat worrisome that there seems to be a lot of money flowing in there.

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Bloomberg:  Where are you finding the best opportunities?

Brendan Murphy:  The best opportunity is just in terms of all-in yields and duration. It’s an attractive environment to take duration risk at a high level. Within the subsection of that, we’d emphasize quality. I’d be cautious about going down in quality to things like high-yield or other riskier parts of the market. So, high-quality yield and more on the front end of the curve. That two- to five-year high-quality part of the market is generally the part we see as most attractive.

Agency mortgages actually look pretty attractive just because the valuations look relatively cheap to investment-grade credit, but that’s another form of an up-in-quality trade. I could sell a BBB-rated credit name and buy an agency mortgage or things like that.

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