Democrats Better for U.S. Bonds Since LBJ Beat Goldwater
The idea that Democrats are big spenders and bad for bonds while Republicans are deficit hawks is being turned on its head in the $10.8 trillion market for U.S. Treasury securities.
Ever since Lyndon B. Johnson defeated Barry Goldwater for the presidency in 1964, yields on 10-year Treasuries have dropped about 40 basis points in the first month when a Democrat wins, and risen 19 after a Republican victory, according to data compiled by Bloomberg. When applied to the $264 billion in 10- year notes issued in fiscal 2012, the difference means $15.6 billion in interest costs over the life of the debt.
This year’s race for the White House between President Barack Obama and Republican challenger Mitt Romney comes as the U.S. faces $1.2 trillion in mandated spending cuts and tax increases starting Jan. 1 if Congress can’t agree to reduce the deficit, which totaled $1.09 trillion in fiscal 2012. Economic output would shrink by 0.5 percent next year, and joblessness climb to about 9 percent if the so-called fiscal cliff isn’t averted, the Congressional Budget Office said.
“It’s the natural expectation that Democrats would be less business friendly and less positive” for equities, Brett Rose, an interest-rate strategist at Citigroup Inc. in New York who has researched elections and their impact on bonds, said in a telephone interview Oct. 9. That’s “consistent with yields going lower. Republicans are more business-friendly, which leads to higher equity prices and higher Treasury yields,” he said.
After Obama’s election four years ago and amid the worst financial crisis since the Great Depression, yields fell by 128 basis points, or 1.28 percentage points, in the first month, the biggest decline. Republican Ronald Reagan’s win in 1980 lifted them by 64, the steepest climb.
Investors have won with both stocks and bonds this year. Government, corporate, mortgage and asset-backed debt has returned 4.39 percent in 2012, according to Bank of America Merrill Lynch’s U.S. Broad Market Index, while the Standard & Poor’s 500 has gained 15.6 percent.
Treasury 10-year yields declined nine basis points last week, or 0.09 percentage point, to 1.66 percent. The price of the benchmark 1.625 percent security due August 2022 gained 25/32, or $7.81 per $1,000 face amount, to 99 22/32. The yield rose to 1.6 at 8:56 a.m. in New York.
Rather than politics, financial markets have been influenced more in recent years by monetary policy.
Yields on 10-year notes, a benchmark for everything from mortgages to corporate bonds, have fallen from more than 5 percent in 2007 as the Federal Reserve cut interest rates to near zero and bought $2.3 trillion of bonds to spur growth. The central banks said Sept. 13 it will add to that by purchasing $40 billion of mortgage-backed bonds a month.
Romney, a former Massachusetts governor, has said he would not reappoint Fed Chairman Ben S. Bernanke, whose second four- year term expires in January 2014. Lanhee Chen, Romney’s policy director, said Sept. 13 that more bond purchases are “further confirmation that President Obama’s policies have not worked.”
Bernanke said that day the central bank didn’t take into account the November presidential and congressional elections in its decisions. “We have tried very hard to be non-partisan and apolitical,” he said at a press conference. “We make our decisions entirely on the state of the economy.”
“A more restrained Fed chairman could be a potential catalyst for rates to move higher,” Mitchell Stapley, the Grand Rapids, Michigan-based chief fixed-income officer for Fifth Third Asset Management, said in a telephone interview Oct. 9. The firm oversees $15 billion in assets.
A Gallup poll of registered voters released Oct. 12 showed the race between Obama and Romney as too close to call. The poll of about 3,050, which has a margin of error of two percentage points, showed 48 percent of respondents would vote for Obama and 46 percent for Romney if the election were held that day.
Since 1964 yields have averaged 5.74 percent under Democrats and 7.46 percent during Republican administrations. During the so-called Great Moderation between 1984 and 2007, when inflation slowed and business cycles were muted, the Republicans were in office four of the six terms.
Low yields suggest investors expect slow growth and low inflation no matter who wins the presidency. Gross domestic product is forecast to expand 2.1 percent in 2013, down from 2.2 percent this year, according to the median estimate of 99 economists surveyed by Bloomberg.
A separate survey shows 10-year yields will likely end the year at 1.76 percent, before rising to 2.02 percent mid-2013 and 2.33 percent by 2014.
“History is not a good guide in this situation because we’re in a very unusual period in which policy is based on unconventional methods,” Darrell Duffie, a finance professor at Stanford University in Stanford, California, and a member of the Federal Reserve Bank of New York’s Financial Advisory Roundtable, said in a telephone interview Oct. 12. “We should not expect a traditional historical response.”
Wars, deficits, economic stress and central bank policies have influenced the most significant movements of the bond market during administrations since 1964.
Johnson, a Democrat who took office after John F. Kennedy was assassinated in November 1963, faced a fiscal drain because of the Vietnam War.
Yields rose to 6 percent in January 1969 when he left office, from 4 percent at the start of his presidency. The federal deficit rose to $25.2 billion, or 2.9 percent of GDP, from $4.8 billion as Johnson funded the war and his Great Society programs.
Inflation then took root during the administrations of Republicans Richard M. Nixon and Gerald R. Ford, accelerating to 12.3 percent in 1974.
That was when the Fed under Chairman Arthur Burns was slow to respond to rising price pressures and the Arab members of the Organization of Petroleum Exporting Countries imposed an embargo on the U.S. in retaliation for its support of Israel in the 1973 Arab-Israeli War, doubling oil prices.
Ford called rising consumer costs in October 1974 “public enemy number one.” Persistent inflation increases pushed the 10-year Treasury yield to 12.4 percent by 1981 from 5.89 percent at the end of 1971.
During Jimmy Carter’s Democratic administration from 1977 to 1981, Fed Chairman Paul Volcker instituted a six percentage- point rise in interest rates in 1980 to 20 percent to battle inflation that had accelerated to a 14.8 percent annual rate.
“I remember the highest yielding security had a yield of 23.09 percent,” said Robert Auwaerter, the head of Valley Forge, Pennsylvania-based Vanguard Group Inc.’s fixed-income group, who started in the bond market in 1978. “I did many purchases above 20 percent.”
During the Reagan administration, with Volcker still at the Fed, yields on 10-year Treasuries dropped from a high of 15.8 percent in 1981 to 9 percent in January 1989.
Democrat Bill Clinton enjoyed a smoother ride as the economy boomed in part because of a bubble in technology stocks.
Yields on 10-year notes fell to about 5 percent when Clinton left office in 2001, from 6.7 percent in 1993 at the start of his term. The U.S. had annual budget surpluses averaging $139.7 billion from 1998 through 2001.
Under Republican George W. Bush from 2001 to 2009, yields dropped from a high of 5.3 percent in January 2001 to a then- record low of 2.04 percent in December 2008, shortly after the collapse of Lehman Brothers Holdings Inc. accelerated the recession that lasted from December 2007 to June 2009.
“I’m not entirely convinced that this year’s presidential election is as significant as it was in some prior election years, given the depression of interest rates by major central banks who continue to fight the great recession and its aftermath,” Jack Malvey, chief global markets strategist at Bank of New York Mellon Corp. (BK), which manages $1.3 trillion, said in a telephone interview on Oct. 12.
“The state of the world’s economy in 2013 and geopolitical risks outweigh the election.”
Year In Office Yield 5 Weeks After Outcome 1964 Johnson, Dem. +0.01% 1968 Nixon, Rep. +0.30 1972 Nixon, Rep. +0.08 1976 Carter, Dem. -0.50 1980 Reagan, Rep. +0.64 1984 Reagan, Rep. +0.00 1988 G.H.W. Bush, Rep. +0.25 1992 Clinton, Dem. -0.16 1996 Clinton, Dem. -0.05 2000 G.W. Bush, Rep. -0.12* 2004 G.W. Bush, Rep. +0.17 2008 Obama, Dem. -1.28 Average Change for Dem. Presidents -0.40 percentage point Average Change for Rep. Presidents +0.19 percentage point * Post-election move counted from Dec. 13 when Vice President Al Gore conceded.
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