Washington gridlock won't change late-cycle realities Washington gridlock won't change late-cycle realities Washington gridlock won't change late-cycle realities

Washington gridlock won't change late-cycle realities

Bonds 7 minutes to read
Althea Spinozzi

Head of Fixed Income Strategy

Summary:  Political shifts in the US can delay or accelerate, but not prevent, the next recession.

Savvy investors have spent a sleepless night as the results of the US midterm elections rolled in. The Democratic Party worked tirelessly to win the House, and today they claim victory; the outcome, however, will be government gridlock. But will these results change the cyclical course of the financial market? It’s unlikely.

The reality is that, regardless of the midterm, outcome, the late economic cycle has already started, and US politics can only delay or accelerate the coming of a recession.

With a Democratic House and a Republican Senate, we’ll see Washington tied in a knot. The Republican fiscal proposals are unlikely to pass, and the current congressional spending will likely be not altered for the next year. The economy is set to slow down as the fiscal stimulus fades and the investigation into President Trump’s fortune will continue to leave impeachment as a possibility. This will not leave Trump any other choice but to focus on foreign policy and to continue to expand tariffs as trade war risks escalate.

This will obviously have serious consequences on the US yield curve and markets as whole. While it may not be necessary for the Federal Reserve to continue on as hawkish a path as it has followed of late, and while Fed chair Powell might slow down rate hikes in 2019, trade war escalation may weigh negatively on long-term yields. This means that while we will see a steepening of the yield curve for the next couple of months, the shorter part of the curve could retreat faster than the longer part of the curve will rise because long-term yields will be constrained by trade uncertainties.

The slow degradation of credits that we are witnessing now will continue and by the end of next year and the beginning of 2020 we might start to see a serious repricing of the credit spreads that will affect equity valuations as well.

We are already seeing the first signs of distress in the credit space. Last month was the first month since August 2017 in which leveraged loan performance closed negative. Although we are talking about a loss of just 0.03% according to the S&P/LSTA Leveraged Loan Total return index, retails investors pulled a considerable amount of money out of leveraged-loan funds on fears that this could be the start of a more major move.

US politics can only delay or accelerate the coming of a recession.

The leveraged loan space has been under increasing scrutiny over the past few years as companies have taken advantage of both the low-interest rate environment and investor appetite for higher-yielding credits to borrow more and more money. Now that credit conditions are tightening, many are of the view that certain of these covenant-lite loans could suddenly default, giving the first blow to a house of cards that has been building up since the financial crisis of 2008.

This makes sense, but it's important to flag that identifying bubbles is not the same as timing their bursts. Although it makes sense to prefer quality over yield, it may still be too early to pull out of higher-yielding instruments as the economy continues to be underpinned by strong fundamentals. 

Regardless of what happened in the midterm elections, we believe that the US credit space will continue to be supported for the next couple of years. As thing settle down after the vote, investors have plenty of choices regarding where to put their money to work.
We continue to be overweight US corporate versus Treasuries. The steepening of the yield curve may be painful for holders of longer-term Treasuries, while the upside of holding short-term Treasuries is limited given that the Fed may still need to hike rates in H1’19 despite an overall less hawkish stance.

This is the reason why corporates play an interesting role in an environment of a robust economy amidst uncertain politics.

While the US yield curve reprices, economic fundamentals will remain strong the next 18 months, supporting the valuations of high-grade corporates. We believe that the shorter part of the curve in the US high-grade space offers interesting opportunities in an uncertain time; we particularly like BBB-rated corporates in defensive sectors.

We are not expecting a major change of heart from the Fed tomorrow. In our view, Powell will probably ‘copy-and-paste’ from previous statements while waiting to see how the political scene plays out over the next few months. This should leave investors plenty of room to position themselves as they please, but it’s important to remember that credit quality is rapidly becoming a priority.


The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer)

Saxo Markets
40 Bank Street, 26th floor
E14 5DA
United Kingdom

Contact Saxo

Select region

United Kingdom
United Kingdom

Trade Responsibly
All trading carries risk. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more
Additional Key Information Documents are available in our trading platform.

Saxo Markets is a registered Trading Name of Saxo Capital Markets UK Ltd (‘SCML’). SCML is authorised and regulated by the Financial Conduct Authority, Firm Reference Number 551422. Registered address: 26th Floor, 40 Bank Street, Canary Wharf, London E14 5DA. Company number 7413871. Registered in England & Wales.

This website, including the information and materials contained in it, are not directed at, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in the United States, Belgium or any other jurisdiction where such distribution, publication, availability or use would be contrary to applicable law or regulation.

It is important that you understand that with investments, your capital is at risk. Past performance is not a guide to future performance. It is your responsibility to ensure that you make an informed decision about whether or not to invest with us. If you are still unsure if investing is right for you, please seek independent advice. Saxo Markets assumes no liability for any loss sustained from trading in accordance with a recommendation.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc. Android is a trademark of Google Inc.

©   since 1992